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Divi's Laboratories: Cash rich operations - Outside View by Luke Verghese

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Divi's Laboratories: Cash rich operations
Sep 24, 2013

The company appears to be growing from strength to strength each passing year

The Family is in full command

This is a 23 year old Andhra Pradesh based pharma company which has four board members with executive management functions. Some three of them sport the surname Divi and one does not have the Divi surname - Mr. N V Ramana-- but he is a member of the immediate family. That is to say all four executive directors come from the ‘family'. Note also the apostrophized spelling of the company name. Divi's Laboratories appears to be steaming along at full speed inspite of all the top slots being held by just one family. This will rank as a unique achievement, in my recollection, in the very annals of listed Corporate India. The company makes do with four manufacturing locations-three of which are located in Vishakhapatnam and one in Nalgonda district in Andhra Pradesh. One of the facilities is an export oriented unit, and two units operate in SEZ zones. The fourth unit is a domestic tariff area (DTA) undertaking. The Rs 2 face value share gyrated from a low of Rs 752 in April 2012 to a high of Rs 1,233 in November 2012 at the BSE during the financial year. The promoters collectively hold 52.1% of the voting stock of Rs 265 m at year end. Just four family members together in their personal capacity hold 48.8% of the outstanding capital. This again is a very unique feature of the company.

An export oriented company

The directors' report states that exports accounted for 90% of gross sales for the year as against 89% previously. The exports to Europe and North America accounted for 77% of the total. The vast bulk of the sales abroad appear to be direct exports. But what exactly is the deal that the company has with its foreign buyers is not very clear. However the financials of the company that are on display in the annual report, if they are truly the figures that they are meant to represent, sparkle, inspite of the very close family association. There are a few apparent warts too, but they are overshadowed by the figures on display. The one apparent wart, if one may call it so, is in the remuneration paid out to the executive directors. They were collectively paid a ‘pagaar and commission' of Rs 506 m during the year, including the Rs 265 m pocketed by the Chairman and managing director. The total employee benefits for the year amounted to Rs 1.91 bn. Thus, the payout to the executive directors amounted to 26.5% of all employee handouts. This would look like an excessive payout per-se. Besides, the payment to the top honcho must also look like a record of sorts in the Indian corporate firmament. The government on its part should impose some checks and balances on such dole outs.

The company is a large sized operation raking in gross revenues of Rs 21.44 bn from operations. It earned revenues net of excise of Rs 21.28 bn up 15.4 %. The revenues include sale of services of Rs 216 m and ‘other operating revenues' of Rs 49 m. The FOB (free on board) value of exports amounted to Rs 18.6 bn. The company also realised other income of Rs 485 m against a higher Rs 658 m previously. (Other income accounted for 6% of pre-tax profit against 9.5% previously). The total revenues net of excise duty and including other income amounted to Rs 21.77 bn. The cost of materials consumed is the largest item of revenue expenditure by far. Being an export oriented unit it imports quite some of the materials consumed. Imported materials consumed amounted to 41.2% of all raw materials consumed. This appears to be the set pattern of all export oriented units. The imported raw materials are less expensive than the locally available brew or some such. The total value of raw materials consumed as per the ‘material consumption schedule' amounted to Rs 8.98 bn. (Not taken into account in this consumption figure is the change in the value of opening/closing inventories). It is not known how the company tackles the situation of a depreciating rupee in the export basket effort.

The margins come from cost controls on material inputs

But the fact of the matter is that the company managed to contain input costs of materials remarkably during the year. The consumption cost of materials including that of purchased goods amounted to 37.5% of net revenues against 41.3% previously, implying its ability to control input costs or in realising a higher sale price for what it has on offer. (Put differently, the consumption cost of materials rose a mere 4.8%. Lower consumption costs also simultaneously led to a sharp hike in the value of inventories at year end, but more on this development later on in the copy. ‘Other expenses'--which includes the cost of power and fuel, and consumption of stores and spares -- at Rs 2.94 bn rose 31%, while employee handouts at Rs 1.91 bn upped 32%. But these two costs relative to the consumption cost of materials were of a relatively minor nature.

Consequently, the pre-tax profit rose 14% to Rs 7.91 bn. After tax provision, the post tax profit was sufficient for the company to declare a bumper dividend of Rs 15 per share on a face value of Rs 2 per share against Rs 13 per share previously. The total dividend payout including dividend tax amounted to Rs 2 bn against Rs 1.54 bn previously. Against a paid up capital base of Rs 265 m the company had humungous reserves and surplus of Rs 25.2 bn. The vast bulk of the reserves are in the form of ‘balance lying in the P&L account'. In theory the company is more than ripe for a very generous bonus issue-though that may not be on the agenda of the promoter director led management. The company last made a bonus issue in 2009-10.

Debt free and oodles of surplus cash

The most significant aspect of the company's operations is that it is debt free--or alteast almost. As a matter of fact the company has a surfeit of cash. This is all the more admirable given the size of its operations and the constant addition to gross block. Also to be noted is that the company carries a ‘load' of current assets. The value of inventories at year end amounted to Rs 8 bn or 38% of net product sales for the year. The value of inventories at the previous year end amounted to Rs 6.5 bn. The trade receivables amounted to a neat Rs 5.59 bn or 26% of net product sales. Add to this the current investments valued at Rs 4.1 bn. (The vast bulk of the ‘other income' comes from dividends received on these investments). Due to these three factors the current assets towered over that of current liabilities at year end. But at the end of the day the finance charges debited to P&L account amounted to all of Rs 17.7 m.

The cash flow statement bears out the relative ease of operations of the company. The company generated net cash from operations to the tune of Rs 4.67 bn during the year. It purchased fixed assets to the tune of Rs 3.4 bn against Rs 2.89 bn previously leaving a lot of surplus cash to play with. The total gross block at year end amounted to an impressive Rs 13.37 bn. The plant and machinery alone accounts for 72% of the gross block. It would also seem that it is a very capital intensive operation given the revenues that the gross block was able to generate.

It is also very nice to know that the company does not support too many siblings. It has just two wholly owned siblings - one based out of the States and the European operations based out of Switzerland. There are four other associates in which key management personnel have significant interest. But Divi's Labs has an equity stake in only the two siblings. It has an investment of Rs 25 m in the US sibling, and an even more pathetic stake of Rs 3.6 m in the Swiss company. It has also advanced loans of Rs 448 m to its siblings. And it also affected sales of Rs 651 m to them. Thus only a small part of the export effort was directed through its own kith and kin.

The siblings don't gel

What exactly was the earthly purpose of incorporating these siblings is not quite known. But not much prior thought appears to have gone into the exercise. Both the siblings together generated revenues of Rs 908 m. In other words they apparently generated a value addition on the purchase cost by Rs 257 m. But at the end of the day this value add did not amount to much. The US company posted a pre-tax loss of Rs 49 m on sales of Rs 620 m, while the Swiss offspring posted a pre-tax loss of Rs 9.3 m on sales of Rs 288 m. Both the companies boast a negative net worth.

For the matter of record the share price oscillated from a low of Rs 752 in April 2012 to a high of Rs 1,233 in November 2012 during the financial year. Considering the promoters hold a slice over 52% of the meagre capital base of Rs 265 m, the floating stock on tap is only a pittance. From the likes of it the company is well worth taking a long look at.

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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