Linde India: Higher transparency called for
It gives the appearance of a company which is driven more by the compulsions of pleasing the principal shareholders than of the general well-being of all shareholders.
Old wine in new bottle
Linde India is the new name plate of BOC India. The name change became effective February 18, 2013-after the closure of its books of account for 2012. The company is a member of the Linde group which operates in more than 100 countries, and is of Teutonic stock. For a period of time during the strict enactment of the Foreign Exchange Regulation Act (FERA--which is now known as FEMA) the company was known as Indian Oxygen Ltd after the foreign shareholding in the company was reduced to below the plimsoll line of 40%. Today the principals hold 89.5% of the equity stake of Rs 853 m. Under the restructured listing guidelines issued by SEBI the public shareholding in a listed company should be alteast 25% against an earlier upper limit of 10%. The alternative is to de-list by buying out the balance public holding. The de-listing option is unfortunately a costly exercise as companies have to pay an emperor’s ransom and some more to get all stakeholders to tender their shares. In the secondary market the Rs 10 face value shares of the company traded from a low of Rs 271 in January 2012 to a high of Rs 530 in April 2012 during the financial year. The volume of trade in most months was however not surprisingly very tepid. The market it would appear does not quite fancy this counter.
Linde India is India’s leading industrial gases company. It operates the country’s largest air separation plant and run more than 20 production facilities and filling stations across the country. It also supplies a wide variety of gases and mixtures and other services such as construction and installation of plants, equipment, pipelines and associated engineering services catering to diverse industries. The other first that the company claims includes the largest sales and distribution network in the country giving it a wide geographic reach.
As the annual report put it the gases and related products segment comprises of pipeline gas supplies to very large industrial customers, gases in bulk and packaged gases for industrial and healthcare segments. Tonnage customers are supplied gaseous oxygen, nitrogen and argon by pipelines directly from the tonnage plants. Gases in bulk consist of liquid oxygen, nitrogen and argon and packaged gases consist of compressed industrial, electronics and special gases. The Healthcare business is served by a mix of bulk and compressed medical gases, such as medical oxygen, nitrous oxide etc.
The working results
So what does this megalith have to show us at the end of the day? The directors’ report is on a rather sombre note. It recorded a subdued performance, the report states, against a backdrop of weak economic conditions and sluggish performance across most industrial sectors -lower demand from major customers, delay in major projects related to customer delays, inflationary trends in power and other costs etc. That translated into an increase in revenues by 16% to Rs 14.1 bn but a sharply lower pre-tax profit of Rs 536 m against Rs 1.75 bn previously. The situation was salvaged somewhat by an exceptional credit of Rs 719 m which helped pre-tax profit to register a figure of Rs 1.25 bn and save face somewhat. The manna from heaven came in the form of the sale of some real estate. Was the sale of land timed only to provide a breather to the bottom-line? In which event it would amount to a very badly timed one off transaction. Was there no other better use of the land? How often in future can the company rustle up such an encore? One would also think that given the fact that it was a market leader - and by some distance at that, it would have some cost control over what it sold, project engineered and serviced to its clients. But it appears not. It is a very competitive market out there.
The company attributes the sharp fall in pre-tax profit to the significantly higher finance costs on long term borrowings and higher depreciation following the capitalisation of new plants. For the matter of record the long term debt rose to Rs 8.5 bn from Rs 7.9 bn previously while the gross block took a sizeable leap of faith to Rs 22.6 bn from Rs 14.7 bn previously. The extraordinary income as stated earlier is in respect of the sale of ‘surplus factory land’ at Vizag and Bangalore and represents the profit accruing from the sale. The finance cost debited to P&L account rose to Rs 404 m from Rs 5 m and the depreciation provision in turn jumped to Rs 1.1 bn from Rs 708 m previously. That represents a cumulative rise in such expenses to Rs 1.5 bn from Rs 713 m previously. For a company the size of Linde it is not such a dramatic jump by any logical reasoning.
Reasons for the fall in margins
The real reasons for the drastic fall in margins lie elsewhere. While the net revenues rose 15% to Rs 13.2 bn the other income fell 74% to Rs 34 m. This is one part of the hit that the company took -albeit small. There was a significant hike in material input costs for one. Such expenses rose 58% to Rs 3 bn from Rs 1.9 bn previously. Employee benefits too took a hit on the bottom-line increasing 32% to Rs 823 m. These were the two main culprits at the end of the day. The person who wrote the copy did not quite get his fundas right. But let that be. The directors’ reports to its members in any case are quite a joke.
Also not quite on the ball appears to be some of the elements that go to make up the cash flow statement. The statement avers that the gross expenditure on the purchase of plant and machinery (P&M) including all capital advances amounted to Rs 2.46 bn during the year. But the fixed assets schedule says that the total addition to P&M during the year amounted to Rs 7.69 bn. The difference is large - very large. I am unable to resolve this anomaly-probably I do not have the full picture. The other anomaly that I am unable to resolve is in respect of the sale proceeds of fixed assets including land during the year. A foot note to the accounts says that the company sold real estate (factory land) situated at Vizag and Bangalore and made a profit of Rs 718.6 m. The fixed assets schedule shows the cost price of land disposed during the year at Rs 1 m. (This land must have been bought eons ago or something). Hence the sale price of this land is Rs 719.6 m. Besides, there is no depreciation on free hold land and hence the profit figure remains unchanged. But the cash flow statement says that the proceeds from the sale of fixed assets during the year amounted to Rs 776.91 m. The cost price of the fixed assets discarded during the year amounted to Rs 177.8 m. This includes land, buildings, plant and machinery, vehicles, office equipment and the like. The accumulated depreciation of the assets sold amounted to Rs 51 m. Hence the profit on sale of fixed assets amounted to Rs 650 m. I am again unable to account for all these disparate entries and notes that the company has given. For the matter of record the company generated substantially less cash of Rs 963 m from operations against Rs 1.9 bn previously dues to some negative changes in some balance sheet figures and post paying higher direct taxes.
Inadequate owned capital
Against a paid up capital of Rs 853 m the company boasts plenty reserves and surplus of Rs 12.5 bn at year end. But the point to note here is that the securities premium reserves alone accounts for 56% of the total. The company also makes do with massive borrowings. The total debt at year end rose to Rs 11 bn from Rs 8.4 bn previously. Inspite of the high debt the interest payout is very favourable to the company -- a very marginal Rs 404 m against and even more incomprehensible Rs 5 m previously. (This manna from heaven in turn enables the company to turn a profit). So how did the company manage to pull a rabbit out of the hat here? What makes it all possible is that the parent company Linde AG has advanced a foreign currency loan of Rs 8.4 bn (Rs 8.4 bn previously) which appears to be debt free. Whether this loan is also insulated against foreign currency fluctuations is not known. How the parent company benefits from such largesse has not been explained either. I guess now that the parent has an iron grip hand on the sibling anything is possible. (Now that the company has to dilute its foreign stake as one option, the logical step to take in such an event is to offer shares at a premium to the public and reduce debt. As it is the company is operating in a very competitive market, and reducing debt is a sure fire way of combating market forces).
But the company does make a go of putting its working capital management under the scanner. The current liabilities at year end for example are higher than its current assets. This is turn helps the company to realign its funds. Inventory levels at year end are at rock bottom levels while the trade receivables amount to 22% of gross sales against 27% previously. Significantly the trade receivables are only marginally higher than the trade payables. But where the company needs to get more bang for the buck is in the sales to fixed assets ratio. The gross block at year end amounted to Rs 22.6 bn against Rs 14.7 bn previously. Taking an average of the two gross block figures (given the massive capex spend during the year) one arrives at an average gross block figure of Rs 18.7 bn. Juxtapose this figure with the net revenues for the year of Rs 13.2 bn. It would imply that the asset turnover ratio was 0.71. Is one to assume that companies that manufacture and supply gases are so overtly capital intensive that they cannot even generate a 1:1 ratio? This is simply out of the world sci-fi stuff. This is another strong reason that Linde India is facing difficulties in generating margins at the end of the day.
The segment revenue schedule further buttresses the point. Have a look at the figures. On segmental revenues of Rs 9.3 bn the gases and related products division earned a segmental margin of Rs 440 m. On segmental revenues of Rs 3.9 bn the project engineering division earned Rs 640 m.
The group inter-se transactions
The other big deal is the inter-se transactions with group companies during the year. According to the schedule it had transactions with 33 group companies-including two fellow siblings in India and one joint venture going by the name Bellary Oxygen Company. The biggest transaction relates to the purchase of capital goods from the ultimate parent and other fellow siblings amounting in all to Rs 5.58 bn. This is indeed a large chunk of money and the purchase was apparently funded by the ‘goldilocks loan’ overhang from the parent. You take some and you give some-that is the name of the game. This is one of the pitfalls of having an overbearing parent. Certain trades are trashed down your throat. And there may even be some quid pro quo here. Separately there appears to be another purchase of fixed assets of Rs 170 m from other group siblings-at least this is the message that I get. There are other transactions on revenue account but they are less significant. Sales to group companies of Rs 950 m is second in the list followed by purchase of Rs 555 m (excluding JVs).
There are a few puzzling entries as respects revenue transactions with group companies. The trade receivables and trade payables from/to group companies for example do not seem to correspond with the revenue sales/purchases affected to/from group companies during the year.
At the end of the exercise the very clear impression that one gets is that this is not a company which is run with all shareholders in mind. The lack of interest in this counter appears to show up in the secondary market 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 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.
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