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Ion Exchange: Appears to be losing direction. - Outside View by Luke Verghese

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Ion Exchange: Appears to be losing direction.
Dec 6, 2010

The water treatment pioneer

Ion Exchange (India) commenced life in Bharat in 1964, as a subsidiary of Permutit of the UK. It chortles that it is the pioneer of water treatment in India. The company became a wholly owned Indian entity in 1985, when the parent divested its entire shareholding in the Indian offspring. Today its writ is a trifle overextended, though its focus area still lies in the recycling of industrial effluents and domestic sewage, and for desalination of sea water. The company also makes and sells domestic water purifiers. Its specialty however is in ‘total environment' solutions.

The medley of operations

The company recognizes its revenues through a medley of operations. Getting a fix on its top line requires some dexterous maneuvering, as different schedules have their own take, not only on how the how the overall revenues are derived, but also the total quantum. The same appears to be true about a number of other schedules on capital account. Its full year revenues per se are increasing at a clip, but the bottom-line, sad to say, is scraping the bottom of the barrel, and for reasons which are entirely the making of the management. Whatever, overall net revenues including service income at Rs 5 bn was a neat 11.8% higher than in the preceding year. The pretax profit too was bountifully higher at Rs 102 m, against a mere Rs 37 m in the preceding year. But pretax profits in either year have obtained considerable help from an item called ‘Other Income'. Such other income at Rs 48 m accounted for 48% of pretax profit in FY10 against a whopping 154% (Rs 95 m) in the preceding fiscal. The constitution of this other income is interesting, but more on this masala mix later.

In its segmental classification of revenues, the top line accrues under four heads - Engineering, Chemicals, Consumer Products, and an item called Unallocated. The first subhead brings in over 62% of revenues, followed by Chemicals with 23% , Consumer Products with 14% and the last subhead bringing in a mere 1%. The margins that these divisions realise are most revealing. The Engineering division begets a pitiful gross margin of less than 1% in both years (this appears to be a very poor management of its acquired skills), while the Consumer product division swims in red ink. It is the Chemicals division which brings home the bacon. The first named, the engineering division also accounts for over 50% of the segmental assets. The total gross margin based on the above equation adds up to Rs 225 m. (For the matter of record the engineering division makes and sells equipment for water and waste water treatment plants. The chemicals division makes and sells the ion exchange resins. The consumer products division makes and sells domestic water purifiers).

A different take on the income classification

A purview of the schedule which gives the details of the installed capacity, manufacturing capacity, production, and sales, gives a more lucid detail of the revenue generation. In this agglomeration, the revenue is generated from the sale of Ion Exchange Resins, Water Treatment Plants and Accessories, Chemical Additives, Consumer Products, and Traded Items. Not included in this classification, is income from services rendered of Rs 364 m, and management fees of Rs 26 m, which are both sales related incomes. The sale of water treatment plants is the top dog, generating over 62% of revenues. What is interesting here is that traded sales appear to bring in large margins. On a rough calculation, based on the difference between the per unit purchase price and per unit sale price, the sales of bought items at Rs 359 m, would have realized this division a profit of Rs 153 m. This arithmetic is a pure play exercise, and excludes any carrying costs, and other unidentifiable expenses.

The mass of siblings

The parent in its wisdom has floated a mass of siblings, as is now de-rigueur for desi companies who think big with blinkers on, and spread themselves thin in the process. It is another matter that due to this clouded vision, they overlook the fact that they are not ‘big' enough or even ‘versatile' enough to manage foreign subsidiaries, but, who is complaining. It currently boasts of 9 subsidiaries and 1 step subsidiary, (including 6 overseas subsidiaries), 7 associates, 1 joint venture, and 1 ‘loaded' entity in which it has a significant influence called IEI Shareholding Trusts, making a total of 19 dependants. The total equity outlay to manage these siblings totes up to Rs 254 m. During FY10 the indulgent parent sold goods and services worth Rs 634 m to 12 of them, and bought goods worth Rs 585 m from four of them, or so the schedules reveal. At year end, the debtors' balances (according to one schedule) due from these siblings added up to Rs 564 m. In value terms it is almost as much as the sales affected to them. (Another schedule shows receivables of Rs 652 m from them, but this may include items of a capital nature also). One payables schedule shows outstanding from the parent to the subsidiaries of only Rs 71 m (but the sundry creditors schedule shows that it owes its subsidiaries over Rs 100 m).

Frankenstein's monster

But whichever way one looks at it, the dice appears to be heavily loaded against the company and Frankenstein's monster has come to haunt its creator. This is partly because many of the subsidiaries have yet to reach the take off stage and one in particular, Ion Exchange Enviro Farms, which makes organic vegetables, of all things, is hemorrhaging badly. To round up the dismal picture is the revelation that IEI Shareholding Trusts owed the parent a whopping Rs 238 m at year end. What in heaven's name is the value addition or is it value deletion of this entity? Does this also have something to do with the Rs 43 m in stock options outstanding at year end? In what way does the company's operations and wellbeing benefit from this exercise?

Facing headwinds

For a company which claims it is India's premier environment solutions company, it appears to facing considerable headwind, in getting paid for, for what it markets to make a living. The total debtors' receivables of Rs 2.4 bn at year end, accounts for almost half of the gross turnover of Rs 5 bn for the year. What's more, trade debtors over six months, accounts for almost half of all debtor dues. This will play heavily on working capital costs, though the company does make amends somewhat by squeezing the hell out of its creditors too.

With the type of margins that it is able to squeeze out from its mainstay operations, it is no wonder that it is so heavily dependent on other income help from the tooth fairy. In FY09, it curiously enough recorded a favorable turn on the derivatives front and recorded an inflow of Rs 43 m as forex gains (it recorded a loss of Rs 29 m in the latter year.) Then there is the rental income of some Rs 25 m that it can always depend on. There are of course no planned returns that it can count on, on the investment portfolio front, from the moneys blocked in its siblings. It can however stage manage some marginal returns on the substantial advances that it has forked out to its sputtering siblings.

An eye opener

The siblings are an eye opener of their own. The only one to shine, and is Bharat based, is Ion Exchange Infrastructure, which is also the biggest revenue procurer. It earned revenues of Rs 607 m and earned a pretax profit of Rs 46 m. It is the only subsidiary to oblige the parent, with a lilliputian dividend of Rs 2 m. This company is a 51% subsidiary of the parent, and is also a clone of the parent, in the sense that it undertakes projects for water treatment and waste management, and does turnkey contracts. The question that comes to mind is the need for a 51% subsidiary to do the same work that the parent performs, and one wonders who holds the balance 49% stake.

The subsidiary going by the name of Ion Exchange Enviro Farms is some sort of a scream. Its accumulated losses have substantially exceeded its paid up capital. It has negative reserves of Rs 133 m, against a paid up equity of Rs 7 m. The directors however have some soothing words to say about its future, but as can be expected, it appears to be more of an acknowledgement of a diversification gone horribly wrong, than any real statement of intent. This 79% subsidiary is turning out to be an expensive proposition. The parent had loans outstanding to the extent of Rs 190 m during the year, and since there appears little scope of getting this money back, the company made the wise decision to issue debentures to the tune of Rs 150 m to it, and convert a bad debt into a secured loan. A neat accounting trick for the present, but one fondly hopes that this additional lubrication will at least bear some fruit in the not too distant future, and not merely delay the inevitable.

The firang siblings

The subsidiaries operating out of Malaysia, Thailand, Bangladesh, Singapore, and such like, are still mere holes in the wall for the present, and still have quite some distance to cover before they can be taken seriously. (The directors' report however avers that there is going to be a renewed emphasis during the year to give more bite to the operations of these juveniles. Hopefully there will also be a renewed focus on setting matters right in the parent company too.) The Malaysian entity is a 60% subsidiary, while the Thai offshoot is a step down subsidiary. The company has even made a foray into the North American market, with a 60% subsidiary, while it has two investment subsidiaries, whose purpose of incorporation beats all logic. The parent also appears to have a penchant for incorporating subsidiaries which are not wholly owned by the parent. There is also a ‘leading' expense entry in the schedule featuring ‘operating and other expenses'. The company has written off Rs 79 m during the year representing doubtful advances, deposits, and claims. Does this write off represent advances etc made to its subsidiaries? Is there any sort of credit risk evaluation that this company follows? One has to consider the fact that the CEO has expensed the company for more than Rs 10 m as ‘pagaar' during the year.

It would help if the management could get a fix of what it should be doing.

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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