The several claims of the management notwithstanding it does not appear to be a very financially well managed organisation
Going ballistic on its achievements
HEG was originally incorporated as Hindustan Electro Graphites Ltd. At some point in its onward journey the company renamed itself to the present avatar based on a vision statement. But the company still primarily makes what it started out making some 40 years ago-electro graphites. The latest annual report prides itself on three factors---It is one of the most competitive graphite electrode manufacturers in the world, it is the largest single location graphite electrode facility in the world, and it is India's largest graphite electrode exporter. The company website adds that 80% of its production is exported to 25 countries around the world. In a year in which the global steel sector grew 1.2%, HEG's revenues grew 14%--thus protecting its record of having grown every single year since 1977. The management appears to be very high on adrenaline. The company makes do withmanufacturing units and a thermal power unit at Mandideep in Madhya Pradesh and a hydro electric power unit in Hoshangabad in Madhya Pradesh.
The company is today run by the second generation Jhunjhunwala -Ravi and his son Riju, the son and grandson of Lakshmi Nivas Jhunjhunwala the founder patriarch of the company and the extended group. The company makes and markets graphite electrodes which are used in heavy industrial electrical arc furnaces to melt scrap steel, to make foundry items, glass, and such like. It was set up originally in collaboration with the French giant Pechiney Ugine Kuhlman who provided the technical knowhow for the project. Presently the management has a more than comfortable holding of over 58% of the outstanding and piddling equity capital base of Rs 400 m-a piddling owned capital base in relation to the size of its operations. (It had total assets of Rs 30.8 bn at year end). The capital base which stood at Rs 428 m in the preceding year suffered an erosion to Rs 400 m following a buyback of shares that the company orchestrated in that year. The buyback cost the company some Rs765 m-dosh which it could well have handled more sanely in a trying year. This is also the most convenient way to increase the holding of the management, with the promoters not having to spend a dime from their own pockets to obtain the desired results.
The promoter holding appears to be scattered. According to the schedule that furnishes 'details of shareholder entities' that hold more than 5% each of the equity capital, there appears to be four investment companies including one based out of Mauritius which collectively hold 38.9% of the equity on behalf of the management. In other words the balance promoter holding of 19.4% is held by individual entities with a level of holding lower than 5% each.
Its product lines
The company makes graphite electrodes and generates both thermal power and hydro electric power. The latter two capacities were created as the manufacture of electrodes is power intensive and it also provides for fail safe power supply. It has an installed capacity of 80,000metric tonnes of electrodes-the same as previously -- and 63 MW of thermal power and 13.5 MW of hydro generating power. The directors' report states that the company commissioned its 14,000 metric tonne brown field capacity for electrodes which operated at optimum capacity during the fag end of the year-the full benefits are expected to accrue going forward. But the fact of the matter is that the capacity levels for electrode manufacture for the two years remains unchanged.
The company realised gross revenues from operations of Rs 16.5 bn against Rs 14.5 bn previously. This is made up of sale of graphite electrodes of Rs 16.2 bn, and sale of power of Rs 301 m. The vast bulk of the power that it generates is consumed internally. The company states that the in-house generation of power is cheaper than outsourced power - but one has no way of knowing for sure. It also generated other operating income from REC sales and fly ash sales amounting in all to Rs 52 m. The income from these two sources was substantially lower in the preceding year-but in any event their effect on the bottom-line is minimal. After deduction of excise taxes the net revenues for the year amounted to Rs 16.2 bn against Rs 14.2 bn previously. It also realised 'other income' of Rs 136 m against Rs 168 m previously. This income is a hotch potch of receipts including provisions no longer required written back, and diminution in value of investments written back, profit on sale of investments interest income, dividends etc. But other income too is very insignificant when compared to the overall pre-tax profit.
Exports are the mainstay
The company booked a slightly larger pre-tax profit of Rs 1.8 bn against Rs 1.6 bn previously before exceptional expenses. This was made possible by a tight control over input costs including material inputs, employee costs and limiting the increase in 'other' expenses. The increase in pre-tax was almost in line with the increase in revenues. What is significant however is the beating it takes on the forex fluctuation front arising out of exceptional volatility in forex rates. In 2012-13 the loss booked on this count amounted to Rs 552 m against an even larger Rs 928 m previously. Apparently the company specialises in taking the wrong call in its forex bets. However, thanx to the lower provisioning in the current year, the profit after provisioning amounted to Rs1.25 bn against Rs 671 m previously.
The point is that the company exports the vast bulk of the electrodes that it makes in preference to that of domestic sale and has to therefore encounter forex calls. In 2012-13 the exports at Rs 13.2 bn amounted to 83.2% of net manufactured sales of electrodes of Rs 15.87 bn against a lower 76.7% previously. Hopefully, export sales is the saner option as compared to domestic sales, and forex losses is the price that it has to pay to earn its bread. The company however does not appear to book any export benefits in its financial accounting. Not only does it export the bulk of what it produces, it also imports the bulk of its raw materials. Over 60% of the raw materials that it consumed were imported. The principal raw material consumption is that of calcined petroleum coke. So, the demands on forex are quite acute.
The industry that it operates in is quite a specialised one. Not only is the industry capital intensive but it is also working capital intensive. As a result or perhaps inspite of it the company is in a sense borrowed to the hilt. In this instance there is also the power division to be taken into account but still. On a gross fixed assets base of Rs 11.7 bn, the company realised net sales of electrodes and power of Rs 16.2 bn or a fixed assets to turnover ratio of 1:1.37. The inventories at year end at Rs 6.1 bn amounted to 38% of net sales, while the trade receivables amounted to 36% of gross sales. But inspite of the high level of current assets, the company managed to leverage the current liabilities - with a huge load of short term borrowings amounting to Rs 10.4 bn thrown in - to almost match that of the current assets (excluding cash and bank balances) at the end of the day. But the fact of the matter is that the company is also shouldered with total debt of Rs 13.9 bn at year end againsta debt load of Rs 12.7 bn previously. In other words it also infers that it is the short term debt which is providing a breather to the liabilities side of the working capital equation.
Interestingly, the interest paid out during the year and debited to P&L account amounted to only Rs 636 m. On a rough basis that would work out to an annualised rate of interest of 4.5%. Considering that all the loans that it has contracted appear to be interest bearing, this percentage interest payout amounts to be very much on the lower side given the prevailing interest rates on debt.
Even given the demands that it has to make on borrowed moneys to fund working capital flows, the cash flow statement shows that the company generated enough cash from operations in the current year to finance fixed assets expansion. The company generated positive cash flows of Rs 1.7 bn against a much smaller Rs 271 m previously. But this cash flow generation is inclusive of an item called 'cash from operating activities' of Rs 1.34 bn against Rs 319 m that it generated previously. It is not immediately known how the company rustled up this figure for either year. The end result was that the cash that it generated from operations was more than enough to fund capex of Rs 1.50 bn for the latter year. In the preceding year the capex spend of Rs 2.1 bn had to be funded mostly through additional borrowings.
Ironically enough, the dividend payment of Rs 374 m (inclusive of dividend tax) in 2012-13 and the dividend payment of Rs 457 m previously were paid out of additional borrowings. The dividend was scaled down in a year in which the book profits were actually higher. Whatever be its bombastic claims, paying out dividend - out of additional borrowings - does not look like such a great idea.
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 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.