Sudarshan Chemicals: Pigments are not adding much color - Outside View by Luke Verghese

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Sudarshan Chemicals: Pigments are not adding much color
Nov 12, 2010

Keeping it within the family

This 59 year old company believes in keeping it small and within the family too, and, every which way at that. Promoted by the Rathi family for a piddling sum of some Rs 50,000, the family has an effective majority control of the company. The paid up equity of Rs 69 m and reserves of Rs 1.4 bn is totally out of depth compared to its turnover and profits. It is easier to keep effective control of one's creation, when the capital representing the voting stock, is kept at a miniscule level, especially given the rise of the third generation in the helm of affairs of the company. After decades of being at it, the company conjured up gross revenues of Rs 6 bn, and a profit before tax of Rs 658 m, accounting figures which would elicit an embarrassed laugh from the likes of someone like say, Mukesh Ambani. But then everyone does not share the same fate, so to speak.

The remuneration aspect

The most fascinating aspect of the company is that 5 members of the promoter family (in the statement of particulars of employees) and four of whom are on the board, derive their sinecure from the company's cash coffers. In all humility one must acknowledge that these family members are academically highly read. Their combined remuneration however adds up to Rs 51 m - that works out to an impressive 11% of all remuneration of Rs 463 m for FY10. And, this is only taking into account members whose names are readily available in the annual report. Add to this their dividend take of Rs 46 m in the past year from their 53% holding and that is a very neat packet, thank you.

What it makes and sells

The company is primarily in the business of making organic and inorganic pigments, effect pigments, and to a much lesser extent agro chemicals (or crop protection chemicals) at their two plants in Maharashtra. Pigments are materials which change the color of reflected or transmitted light. Pigments have wide uses including as industrial pigments (automotive, engineering) and applications that go from paints, ink, plastics, fabrics, cosmetics, and food. But, the company is only one of the numerous such units that dot our countryside, though the management states that it also produces high performance pigments, and customized pigments for niche segments. Pigment manufacture can hardly be classified as high tech, though it is characterized as hazardous. Consequently, given the environmental cost, there has been a shift of manufacturing units from the West, to India and China. The Chinese, the company complains, have set up large manufacturing units along with the key intermediates required for pigments. This makes it difficult for Indian companies to compete. The Chinese companies are apparently turning the heat on, in the domestic generic pesticide market too. What prevents Indian companies from emulating the Chinese and taking the fight into the enemy camp? Significantly, it is a question which the management of Sudarshan has left unanswered.

How the figures add up

In FY10 the company earned over 86% of its net manufactured sales of Rs 5.6 bn from pigments, with agro chemicals bringing in the balance. Pigments also accounted for 92% of the pre interest, pretax profits with agro sales bringing in the balance. But, importantly, the pigments division accounted for 97% of the total capital employed. Exports totted up turnover of Rs 1.8 bn, or a sizeable 33% of net turnover of Rs 5.6 bn. The exports were almost wholly of the pigments variety. The increased emphasis on exports has emboldened the company to set up 2 subsidiaries, one each in North America and in Europe, ostensibly to fast forward matters on this score. But, interestingly enough, its new markets appear to be emanating in Africa, South Asia, and South East Asia. But more on this subject later.

Investments in manufacturing capacity

The overall 26% rupee growth in turnover was on the back of a sharply higher production of inorganic and organic pigments, and pesticides. The higher production followed a substantial increase in the production capacity of inorganic pigments to 10,422 tonnes (5,802 tonnes) and a lesser percentage hike in the production of organic pigments to 10,081 tonnes (9,235 tonnes). There was also a renewed emphasis to make better use of its pesticides plant, and hence production rose to 1,839 tonnes from 959 tonnes in the preceding year. However, with a production capacity of 3,520 tonnes, this plant is still substantially underutilised. It may be pertinent to add here that in the last two years the company spent Rs 460 m on topping up its productive assets, (not including what its 3 little sissies have been up to). Small beer by today's megabuck spends, but the company believes that small is also beautiful. However this sudden spurt in activity levels brought about a resounding change in the bottom-line, with pretax profit growing to Rs 657 m from Rs 283 m in the preceding year. The company was also infinitely lucky that the forex market went in its favor, adding Rs 37 m to the cash kitty in the process.

The profit/ cash flow conundrum

The interesting feature about profits and cash flow is that the two may be pulling in opposite directions at the same time. Though profits surged, the cash generated from operations went in the opposite direction. The net cash generated from operating activities declined to Rs 429 m from Rs 533 m in the preceding year. The larger profits, then, were generated from higher inventory levels, and higher debtors holding (up by 62%) at the working capital level. The extra funds outflow on these accounts was however negatived by applying the guillotine on creditors. With the management keeping business activity kept within reasoned limits, there was little strain on the company's working capital needs, and hence long term debt grew only marginally.

The subsidiary factor

As stated earlier the company has decided to give a push to its export effort and become a global pigment company in the process. With this objective in mind the company has set up two overseas subsidiaries. These subsidiaries the company claims, have done the necessary spade work for the future export thrust. But, the fact of the matter is that, the company has already been exporting its product range long enough, so the moot question is what is the extra spade work that these companies have put in. Further, the investment schedule does not give any information of any investments made in the North American subsidiary, though this subsidiary was incorporated in April 2009 with a paid up capital of Rs 14 m.

The European subsidiary rustled up a turnover of Rs 143 m in the latest accounting year, but not surprisingly, recorded a loss of Rs 32 m. It boasts a paid up equity of Rs 82 m. The North American sibling however had the signal honor of recording a loss of Rs 12 m, which was 6 times greater than that of its turnover! One wonders at the pressing need by companies to set up subsidiaries in lands far away to attain results which do so little to add to the well being of the parent. It also makes do with another Indian domiciled subsidiary, going by the name of Prescient Color, which apparently makes and sells pigments for the Textile and specialty plastics segments. The kindly and good hearted parent has invested Rs 100 m in its capital. This sibling is a little more firmly established with sales of Rs 266 m, but with a pretax loss of Rs 3.5 m. Apparently in the managements' reckoning the parent was becoming a little too big to manage, and hence the effort at adding some color to the scenery. All the subsidiaries depend on large handouts from the pater, in the form of loans, for their sustenance. It will take quite some time before the parent can extract any dividend from its collective investments of Rs 200 m.

How the cash has moved

The other interesting aspect of the company's operations is the shift in the debt pattern. The emphasis has shifted to unsecured loans from secured loans. The quantum of unsecured loans has risen 124% to Rs 408 m. This amount is largely made up of intercorporate deposits, and fixed deposits from 'others.' On the asset side, the advances and loans to subsidiaries total Rs 172 m. The external auditors have deemed it fit to comment on some of the happenings. The auditors' state that the company has granted loans amounting to Rs 245 m to two parties listed in the register. Of this amount, Rs 172 m was apparently advanced to one of the subsidiaries. There is no separate information in the balance sheet on where the balance Rs 7.3 m went. The auditors go on to state that the company has taken loans to the tune of Rs 172 m from 11 parties listed in the register maintained by the company. But the auditors also add that the rate of interest on the loans taken and granted by the company, and the other terms and conditions are not prejudicial to the interest of the company. The auditors also state that the company has issued corporate guarantees on behalf of Prescient Color amounting to Rs 123 m to the banks for loans availed of by the sibling. The sibling is turning out to be a very expensive idea whose time has yet to come. Incidentally, the word 'Prescient' also means 'foresight'. One fondly hopes that this company has got its bearings right.

This is not a company that excites one's mindset, given the manner in which the management is taking the company forward. Not that they care one bit.

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.


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