The annual report of Bayer CropScience needs to be more forthcoming on its financial performance yardsticks, and on shareholder benefits.
A complex organization
Bayer Cropscience is a complex organization in more ways than one. The company itself is a sequence of serial mergers in the years' past, and even underwent rebirth. It was formed in 2002 through Bayer's acquisition of Aventis Crop Science. The latter in turn was formed in 2000 through the merger of AgrEvo and Rhone Poulenc Agro. There have also been several other material twists and turns in its corporate existence. The Indian offspring in turn is owned by three foreign entities - Bayer CropScience AG, Bayer AG, and Bayer SAS, and one Indian headquartered company Bayer MaterialScience Pvt Ltd, and between them own a commanding 71.1% of the outstanding equity of Rs 394 m.
The group itself is a humungous operation to say the least, and the parent has some 474 affiliates across the board, or so the annual report reveals. These companies in turn are dotted across the globe and include several companies operating within the confines of the same country. There are for example nine companies operating in India - Bayer BioScience Private Ltd, Bayer Business Service Private, the colorfully name Bayer Malibu Polymers Private, Bayer MaterialScience Private Ltd, Bayer Pharmaceuticals Private Ltd, Bayer Zydus Pharma Private Ltd, Bilag Industries Private Ltd, Nunhems India Private Ltd, and the company under review. One wonders what they are all up to. As can also be seen, Bayer CropScience is the only publicly listed company among this list, and given the constitution of its siblings, may well sooner or later go private.
Revenues juxtaposed between manufacturing and trading
Its operations too are about as complex as it can get. It manufactures, and also buys and then sells 'a host of sustainable crop protection solutions from seed to harvest'. Its products thus cover the entire hog of agricultural operations end to end. In the midst of this turmoil the company's net sales (including operating income) has risen to Rs 21.4 bn in 2010-11 from the Rs 6.5 bn that it recorded for the calendar year ending December 2001. That amounts to a 226% increase in revenues over 9 years. Within this, the export revenues rose to Rs 3 bn or an increase of 556%. In other words export revenues accounted for 14% of total revenues in 2010-11 against 7% in 2001. However the contribution of bought out sales (which by 2010-11 was significant) in this revenue figure is not determinable. Pre-tax profit on the other hand zoomed 1128 % to Rs 2 bn from Rs 162 m previously. Whether the higher percentage share of export revenues in overall revenues, or the increasing importance of bought out sales in the overall concoction had a hand in the disproportionate increase in the pre-tax profitability over the years is not known.
The gross block of Rs 2.4 bn rose to Rs 5.6 bn over this period or a rise of 129%. But the influence of bought out sales is clearly visible here. In 2001 the gross block ratcheted up a turnover of 2.7 times. By 2010-11 the ratio had grown to 3.8 times. The difference is not due to more bang for the buck. The other notable feature of the 10 year statistics is the employee compensation. The total number of employees at year end each year flip-flopped in a zig-zag manner right through the ten year stats, but the average compensation per employee on a rough basis rose alarmingly from Rs 402,000 in 2001 to Rs 1.5 m in 2010-11! This company would appear to be a high wage island or something.
Shareholder benefits on a hazy wicket
The group's policy on rewarding shareholders is not known, or whether they have one in the first place for that matter is unknown too. The company is rather tightfisted when it comes to paying its tithes to the shareholders and there is no fixed pattern in this respect either. In 2001 the dividend payout was 35% of the EPS (earnings per share). It fell to 23% the nest year, and rose to 33% by 2004. It then flip-flopped over the next few years, and accounted for 12% of EPS for 2010-11. It is just as hard to come by in the matter of other shareholder freebies. That is to say there was not a single issue of bonus shares in the last decade. The debt burden also appears to have the strange habit of see-sawing, and is quite unrelated to the level of the gross block. The point here is also that there was probably a need for a higher level of working capital, because of the increased emphasis on traded sales.
The many sides of the revenue cake
Whatever, this company makes and sells formulations of liquid, powder, and wetable dispersable granules, and also seeds, active ingredients (a pesticide that is biologically active), and Others. It also outsources all the items that it makes, and besides, almost entirely outsources seeds, and completely outsources what it terms as 'Others'. Outsourcing as stated earlier is becoming big business for Bayer. The total value of purchases amounted to 49.2% of net sales, against a slightly lower 41% in the preceding year. The biggest individual contributor to individual sales is liquid formulations which tossed in 36% of all revenues, followed by seeds and 'Others' with 15.3% and 15.8% respectively. (The sale value of 'Others' rocketed to Rs 3.3 bn from Rs 1.7 bn previously - the biggest percentage jump in the breakup). Next in line was Powders with a contribution of 14.8%. Sales of Wetable granules and Active ingredients brought in the balance moolah. The real eye catcher here is in its production of 'wetable dispersable granules'. Against an installed capacity of 720 tons it produced 13,370 tons. This would make for Teutonic magic mantra at its cleverest, and if the company has not patented this ability, it should then share the secret of how it goes about doing so with other companies too. The company does not appear to separately give the value addition that outsourced goods generate on sales, and any conclusions in the matter will therefore tantamount to pure conjecture.
The significance of outsourced sales
It would help if the company does the honors in this respect, as outsourced products account for well over 50% of all sales. What is more, the purchase of goods from related parties in 2010-11 amounted to a whopping Rs 7.2 bn. Conversely, the sales of goods to related parties amounted to another Rs 2.4 bn. The related party transactions as identified by the management alone numbers 49 entities - including seven India based group companies. Then it had 'other operating income' which is all about 'Recoveries from Group companies and third parties' amounting to Rs 1 bn, against Rs 993 m previously. There are numerous other inter-se transactions on revenue and capital account, including such year-end capital account nomenclatures as 'Outstanding receivables net of payables' of Rs 98 m, and 'Outstanding payables net of receivables' of Rs 970 m. What in heaven's name are these concoctions please? The objective of an annual report should be to educate rather than to beguile.
The drop in profitability
The point here is that the company suffered a big drop in profitability in 2010-11 inspite of a sharp surge in rupee sales - and a point which has not been adequately addressed in the main body of the directors' report. As stated earlier, merchandise sales grew a slice over 25% to Rs 20.4 bn. Other operating income rose marginally by 1% to Rs 1 bn. But the pre-tax profit was stagnant. The solitary culprit here appears to be the 44% increase in the purchase value of goods outsourced to Rs 9.5 bn. The value addition on sales of these outsourced goods appears to have been minimal - or have I got it wrong, perhaps? What was the rationale in procuring such a large increase in the value of traded goods when the company was unable to make any headway in the bargain? Was the company seeking to establish a beachhead with its new products? If so it had to face a heavy headwind.
What is more, the company appears to have increased its advertising budget by 30% to Rs 1.1 bn, possibly to take care of the additional load. (On top of the surge in production and purchase of goods, the inventory write off has accelerated to Rs 71 m from Rs 47 m previously). Not taking into account the many ups and downs on the provisions for doubtful debts, and the write-backs from provisions too. Mercifully enough, the royalty payment actually fell to a piddling Rs 13.6 m, from an equally piddling Rs 15.6 m previously.
The management of surplus funds
The other puzzle is the manner in which it goes about managing its surplus funds vis-a-vis the debt it has accumulated. At year end the surplus funds invested in liquid debt schemes amounted to Rs 866 m against Rs 628 m previously. It earned a dividend income of Rs 17.8 m on these instruments. On a rough basis that amounts to a return of 2.4% on the average of the year end balances. If it made any money in turning over this portfolio during the year, there is no evidence of any profits so accruing. It also boasted of a debt portfolio of Rs 1 bn at year end, which is marginally lower than the Rs 1.1 bn that it had on its books previously. The interest charges that it has debited to the P&L account on a 'very rough basis' works out to a slice over 7% on the debt. (The exact percentage interest is impossible to calculate as the tenure of the inter-corporate deposits (ICDs) is unknown). On the face of it there appears to be a severe mismatch between what it receives and what it pays out even taking into account the tax breaks that it enjoys on dividend receipts. Besides, the entire debt in the latter year consists of inter-corporate deposits. The way it pans out is that Bayer CropScience contracted ICDs worth Rs 4.3 bn during the year from Indian group companies, and at year end it had Rs 1 bn on its books. Presumably this interaction is resorted to in the best interest of Bayer CropScience.
Needs to be more forthcoming
It will help if the annual report is a little more forthcoming in subsequent years in the critical matter of the company's working that is disclosed to shareholders, so that they can take a more reasoned view on what lies ahead. Bayer is after all a big international brand and should make an effort to lead by example.
Disclosure: I hold 425 shares in Bayer Cropscience
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.