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Universal Cables: An unimpressive performance - Outside View by Luke Verghese

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Universal Cables: An unimpressive performance
Sep 17, 2010

A brief account

Universal Cables is yet another flag bearer (like Birla Corporation) of the erstwhile MP Birla group which today is under the control of the Lodha family. The annual report of Universal Cables also dutifully carries the photographs of the three late stalwarts, MP Birla, his wife Priyamvada and Mr.Rajendra Lodha. In doing so it was meekly following in the footsteps of the 'parent' company Birla Corporation. But the striking difference here is that the annual report of Universal Cables does not proclaim on the cover, in bold letters, as Birla Corporation did, that it is a member of the MP Birla group. It was the anointing of Rajendra Lodha as the de facto owner of the group following Priyamvada's demise that led to the soap opera which was played out in the Kolkata High court. Mr. H V Lodha is currently the chairman of the Board of both companies. Incidentally, Birla Corporation holds a mere 2% of the paid up equity of Universal Cables. One wonders at the probable convoluted route used to by the parent to keep its hold over Universal Cables. This company too gives the brief working results for the past, though for 5 years only - but by God's grace it is in a sequential order.

Wrong conclusions about profitability

The directors' report is more than a scream; companies imagine that all shareholders are a bunch of idiots, at all times. The report caw caws about achieving another milestone -recording the highest ever net profit of Rs 270 m-higher by 288% over that of the preceding year. This part of the claim is wholly correct. The report goes on to add that the "true hallmark of its impressive performance is due to its sharp focus on the bottom-line improvement by reformatting its business portfolio with major thrust on high end projects and turnkey projects." This part of the claim is loaded with top spin.

Anyway, just to spice up matters the directors should have also added for good measure that the increased profits were achieved on gross revenues which were lower by 18% at Rs 5.3 bn. (The refocusing of the business portfolio possibly led to a 50% decline in the outgo of excise duty to Rs 319 m). For sure the company recorded significantly higher gross margins from the sale of its two product lines, Power Cables and Optic Fibres. It achieved margins of 9% and 10.8% respectively against 5.6% and 0.94% in the preceding year. Also lending a helping hand on the profit front was the contribution of traded sales. Traded sales were higher by 60% and brought in a gross margin of Rs 67 m against Rs 51 m in the preceding year. But, higher expenses on account of personnel costs, inventories, and operating expenses negated the gains on the gross margin front.

The real reasons for increase in profits

In reality, the prime reason for the massive increase in pre-tax profit is thanks to another significant factor. Namely, the preponderance of 'other income' in the pre-tax profit. Other income rocketed by 171% to Rs 206 m from Rs 76 m in the preceding year. Simple arithmetic will show you that other income contributed to 50% of the pre-tax profit in the latest accounting year. Other income constituted an even more impressive 68%, but on a significantly lower pre-tax profit, in the preceding year. The makeup of this other income is just as significant.

Some 64% of this other income, or Rs 132 m, is made up of extraordinary items. That is to say it is mainly constituted by items which are not of a recurring nature-a large profit on sales of assets, forex gains, excess provision for doubtful debts written back, and industrial investment promotion assistance. If one wants to push the case even further, then add to this amount the duty drawback on sales, which per se amounts to an impressive Rs 16 m, and it further skews the already 'topsy-turvy' figure. As a matter of fact if the forex income is also juxtaposed, it gets even more bizarre. In the preceding year the company incurred a forex loss of Rs 23 m against a forex gain of Rs 26 m in the latest year. That in effect works out to a bottom-line gain of Rs49 m in the latest year.

How it generated profits

And how did the company achieve the profit that it generated, on the disposal of its fixed assets? It resorted to some very deft moves in conjunction with an obliging nod from its joint venture partner. The company incorporated a new joint venture with its Japanese partner called Birla Furukawa Fibre Optics Limited. It invested Rs 224 m as equity (45% holding) in this venture (4.5 m shares of Rs 10 each face value for Rs 224 m, implying that the company paid Rs 49.80 per share.) It then apparently sold fixed assets for Rs 135 m from its fixed assets base to this JV. This sale appears to have netted the company a neat profit of Rs 85 m! By all accounts that was a 'fab' transaction. The company also appears to have paid with one hand what it received with the other hand.

Difficult funds management

What is equally pertinent is that in a year in which it claims to have put into effect superior operating skills, the cash generation from operating activities actually declined by 38% to Rs 392 m from Rs 628 m previously. And what pray, was the cause for this anomaly? A significant negative change in the working capital movement during the year was the magic mantra. This was caused either by market forces or by inept management of resources or a combination of the two. More to the point the causes that led to the negativity were an increase in inventories, an increase in loans and advances, and a decrease in current liabilities---though it was partially offset by a decrease in trade debtors. So what is the management crowing about please?

Its joint ventures

What is very intriguing is that its equity holding in each of the companies that it promoted appears to have been acquired at a premium on the face value. It holds 29% of the outstanding equity, or 3.5 m shares, in Vindhya Telelinks (which makes telecom cables). The average cost of acquisition of each share of Rs 10 each comes to Rs 54.90. Ditto with its cost of acquisition in Birla Ericsson Optical Limited. It holds a mere 13% of this company's outstanding equity, or 3.9 m shares. But the cost of acquisition of each share works out to Rs 21.79. And, dividend wise its return on these long term trade investments is pitiful. A miniscule Rs 2 m as dividend income on its various trade investments, toting up to an enterprise cost of Rs 283 m.

Star export house?

Equally befuddling is the elevation of the company to the 'Star Export House' category. The company earned foreign exchange to the tune of Rs 439 m during the year. But the outgo on forex was 4 times higher at Rs 1.8 bn! The latter due to a 54% hike in the value of raw material and finished goods import costs to Rs 1.6 bn. On what basis is the star category decided on by please? The Government's left hand does not appear to know what its right hand is doing.

Electric power cable and telecom cable companies operate under severe operational constraints due to the heightened competition, and the volatility in the input cost of copper, aluminium and polyethylene, but this has not deterred market persons from marking up the price of the share in the secondary markets from a low of Rs 34.5 in April, 2009 to a high of Rs 99.7 in March, 2010.

Disclosure: Please note that I am not a shareholder of this company

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:

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