An agglomeration of businesses, and not really much to show for it at the end of the day
A multitude of businesses
The Kotak Mahindra group is an agglomeration of financial businesses. The standalone bank-the parent is into consumer banking, commercial banking, wholesale banking, and wealth management. That is to say it operates in businesses that all other Indian commercial banks do. It also has a multitude of other businesses - ranging from stock broking, investment banking, mutual fund, life insurance, alternate asset management. These businesses are run through independent corporate entities. Then there are its international businesses. Kotak Mahindra UK, Kotak Mahindra (International) Ltd, Kotak Mahindra Inc, and Kotak Mahindra Financial Services Ltd. ( Mr Uday Suresh Kotak in his personal capacity owns 41.3% of the outstanding paid up equity of Rs 3.7 bn - face value of Rs 5 each while the promoters together hold 45.3% ). This holding pattern would infer that the other co-promoter, the Mahindras, have only a middling stake, if any at all. A very strange state of affairs if one may add. Why then have the Mahindras lent their brand to this company please, or to numerous group companies for that matter? What's the real deal here?
The consolidated results include the working of the parent, and 15 siblings. Then there are its two associate companies. Chronologically the group is 27 years old, having commenced its innings in 1985.The consolidated group rustled up a gross income of Rs 130 bn and a net profit of Rs 18.5 bn in 2011-12, against figures of Rs 110.6 bn and Rs 15.7 bn in the preceding year. The standalone company on the other hand, cobbled up revenues of Rs 71.5 bn, and a net profit of Rs10.8 bn, against figures of Rs 49.7 bn and Rs 8.2 bn previously. Thus the value addition of the group vis a vis that of the parent company in 2011-12 was Rs 58.5 bn in revenue terms and Rs 7.7 bn in the bottom-line segment.
A sharp increase in revenues
The revenues of the standalone enterprise grew 44% over that of the preceding year. Of this, interest income (comprising of interest/discount on advances/bills, income on investments, income from investments, interest on balances with Reserve Bank of India (RBI), and other interbank funds etc) amounted to Rs 61.8 bn. A compilation called 'Other Income' accounted for the balance Rs 9.8 bn. The latter includes such concoctions as commission and brokerage of Rs 5.7 bn, profit on exchange transactions Rs 1.2 bn, profit on recoveries of non-performing assets acquired of Rs 1.3 bn, profit on sale of investments of Rs 816 m, income earned from subsidiaries of Rs 548 m and miscellaneous income of Rs 138 m. Some of these incomes amounting in all to Rs 3.8 bn, though a constituent of the main operations, are highly subjective, and their accretal in any year would appear to depend on the luck of the draw, and cannot be counted upon for an encore each year. The point is also that 'Other income' per se also accounted for 90% of the net profit of Rs 10.8 bn for the year, against an even larger 95% of Rs 8.2 bn previously.
The other income factor
But the company can argue that but for the main income, the other income would not have materialised. The net profit for the year has been arrived at after deducting for 'Provisions and contingencies' of Rs 5.7 bn. This provision is made on some technical formula which would appear to be total Greek to the uninitiated. It is not known where exactly the tax provision of Rs 5.1 bn has been debited as it does not appear to be separately shown in the P&L account statement. There is a possibility that it is accounted for in the Provisions and Contingencies account. It would appear from the above data that the bank's operations are no different from that of other run of the mill public sector banks operating in India.
The directors also follow a very conservative dividend payment policy. The total dividend payout including dividend tax at Rs 517 m is but a mere 4.8% of the net profit for the year. This compares favourably with the payout of 5% in the preceding year. Erring on the side of caution perhaps? Could one infer from the dividend payout that the directors' are unwittingly sending out a message of sorts to its target publics?
Depressing cash flow generation
From the cash flow statement it would appear that the bank cannot even generate a positive cash flow from operating activities. As a matter of fact the company recorded an impressive negative cash flow of Rs 13.3 bn on this score against an even more notable negative cash flow of Rs 14.7 bn previously. The chief 'culprits' here are the massive shifts in some working capital assets -- investments in group companies, and the big jump in advances. The increase in deposits and the increase in borrowings could not help to stem the tide against the overall negative cash generation. As a matter of fact the company was also out of pocket in its financing from investing activities too. It spent over Rs 1.4 bn in the purchase of fixed assets, and consequently 'lost' out here too. It is in financing activities arena that any corporate can make good the aberrations on the earlier two counts. The company went in for a massive increase in refinancing loans to the tune of Rs 12.8 bn and set right its books.
In the borrowings schedule in the section classified as deposits, demand deposits accounted for 19% of all deposits, savings bank deposits brought in another 13%, and time deposits accounted for the balance 68%. The total amount of such deposit borrowings toted up to Rs 385.4 bn. (Demand deposits accounting for 31% of all deposits, and time deposits accounting for the balance 69%). Other direct borrowings included borrowings in India of Rs 126 bn, and borrowings outside India of Rs 40 bn, totalling in all to Rs 166 bn. In short, demand deposits and time deposits together accounted for almost 70% of all such liabilities of Rs 551 bn (Rs 385 bn + Rs 166 bn). The percentage contribution of each head in the borrowings schedule was roughly the same in the preceding year too. Also, the emphasis is very clearly on long term deposits in the deposit section of the borrowings basket.
How the bank earns and expends
As stated earlier the bank earned interest on advances/discounting bills etc of Rs 48.6 bn, and income from investments of Rs 13 bn. Interest on balances with and RBI etc, and Others, brought in the balance pittance. On a very rough basis the interest earned during the year on advances, bill discounting etc amounted to a yield of 12.4% of the year-end balance against 11% previously. (Out of the total sum of Rs 390 bn shown under the heading Advances, the advances made to the priority sector at Rs 123 bn accounted for 31.5%). The interest earned on investments likewise yielded 6% against 5.6% previously. The interest return on its balances with RBI etc is not quantifiable even by a long shot. But it may be noted that that the bank earned an interest of only Rs 41 m during the year on such deposits etc, against a much larger Rs 172 m previously.
On the other hand, and in a similar measure, the interest expended on its deposit borrowings at Rs 25 bn works out very roughly to 6.5% against 5.1% previously. Curiously, the interest on RBI and inter bank borrowings at Rs 7.7 bn would appear to be in the region of 10% against a much lower 5.4% previously. There is another interest payout amounting to Rs 3.9 bn. This payout could have been affected on borrowings from other institutions etc amounting at year end to Rs 50 bn. If so the interest payout may have averaged around 7.7% against 8% previously. From the above data the bank appears to have lost out badly on the interest paid out on borrowings from RBI and other inter bank borrowings. The only surmise is that there was a much larger recourse to such borrowings during the year relative to that of the preceding year.
Thus the spread in interest rates between what it earned and what it borrowed narrowed in a real sense of the term. That is to say the total interest that it earned rose 48% to Rs 61.8 bn, while the interest that it paid out grew 75% to Rs 36.6 bn. What saved the day was a dual benefit exercise. Other income as stated earlier grew over 25% to Rs 9.8 bn; while operating expenses grew only 18% to Rs 18.3 bn. (The biggest item of expenditure by far under this head is employee handouts which grew to Rs 9 bn from Rs 7.8 bn previously). Consequently the net profit for the year rose 33% to Rs 10.8 bn. All in all, it is a very insipid performance.
The many investment avenues
The company has investments both within India and outside India. The book value of investments in India at year end amounted to Rs 215.5 bn, while the book value of investments outside India was valued at Rs 138 m. Of this total, the investments in subsidiaries and joint ventures were valued at Rs 3.4 bn. The company has published the working results of 15 subsidiaries. In reality there are 16 subsidiaries. (Yet another schedule shows that the company makes do 21 subsidiaries. The five additional companies in this listing do not sport the prefix Kotak or Mahindra for that matter. But let that be.) It will help if companies come clear on such matters. The list of 16 includes a company by the name Global Investments Opportunities Fund Ltd incorporated in Mauritius and its capital structure is made up of redeemable participating shares-whatever that means. A footnote adds that the parent has no direct or indirect economic benefits from this investment! At least this is my humble understanding of the message. Barring one sibling, the insurance venture, all the others are 100% subsidiaries of the parent bank.
As stated earlier the consolidated results (which include the profit share of 2 associates) jacked up gross revenues of Rs 130 bn including 'Other income' of Rs 45 bn. The value addition in revenue terms is a very impressive Rs 58.5 bn. As one can see the 'other Income' component accounts for a large helping of the overall gross revenues. The other income component is helped along by receipts under the head of Premium on insurance business of Rs 28.9 bn and commission, exchange and brokerage of Rs 14.5 bn, totalling up to Rs 43.4 bn. The net profit for the year is Rs 18.5 bn.
The 16 entities collectively have a paid up capital of Rs 5.9 bn. Of this, the lion's share is taken up by just one company - Kotak Mahindra Old Mutual Life - with a paid up capital of Rs 5.1 bn. Five of the 16 siblings are incorporated offshore - two in Mauritius, and one each in the UK, USA and UAE. Collectively they generated revenues of Rs 61.3 bn, and a pre-tax profit of Rs 10.7 bn. Nine of the 16 siblings disclosed a bottom-line steeped in blue ink or is it black ink - but not one of them had the gumption to declare any dividend. Not that anyone is complaining however. (One reason then that the parent's total returns on its investments are only a piffling amount). One of the two big boys in this list, operationally speaking, is the afore-mentioned insurance company. It had total assets of Rs 100.5 bn including investments to the tune of Rs 87 bn, revenues of Rs 31.8 bn and a profit before tax of Rs 2 bn.
The big players
The other equally big player is Kotak Mahindra Prime, the non banking financial services undertaking. It has a miniscule capital base of Rs 35 m, total assets of Rs 153 bn, including investments valued at Rs 7 bn, revenues of Rs 18 bn and a pre-tax profit of Rs 5.7 bn. To have such humungous assets on a pip squeak capital base is called the power of leveraging - a facility window that NBFCs' use to their maximum advantage. At number three in the sweepstakes is Kotak Securities (no Mahindra in its name) which on a piffling paid up capital base of Rs 16 m generated humungous revenues of Rs 6.1 bn, and a pre-tax of Rs 1.9 bn. But, then, brokerage firms generate revenues which are completely out of sync with their ability to generate a bottom-line. It also boasted total humungous total assets of Rs 26.8 bn including investments of Rs 2.8 bn. The only other companies in the billion rupee revenue list are Kotak Mahindra Investments and Kotak Mahindra Asset Management which rustled up revenues of Rs 1.2 bn and Rs 1.1 bn respectively.
Four of the five offshore companies are operating in the red - but barring the UAE offspring they possess positive reserves at year end. The fifth sibling has no assets or income accruing to the parent. It would appear from the brief details made available on them that the siblings collectively are on a better footing than the parent.
All in all, this is not a company that will exude much confidence in the mindset of an investor.
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.