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Unichem: Profitability waxing and waning - Outside View by Luke Verghese

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Unichem: Profitability waxing and waning
Dec 10, 2012

Touching human lives it sure is, but the management should also explain the wayward financial performance of its associates

A year shy of its golden jubilee

is just one year shy of celebrating the golden jubilee of its corporate existence. Whether the forthcoming birthday will be an occasion to celebrate through an issue of free shares is not known, but the most eye popping statement that the company proffers through its balance sheet is that the reserves and surplus at Rs 7.1 bn towers over that of its paid up capital base of Rs 181 m as on March 31, 2012. That makes for a ratio of 39.4:1 in favour of the former. The vast bulk of the reserves constitute 'surplus lying in the P&L account'. Tied reserves are almost negligible. The company used to be an avid issuer of free shares in the now bygone years, having made five issues between the years 1969-70 and 1986-87. Since then it made a further three issues with the last offering affected in 2003-04. Subsequently the trail has gone cold so to speak. The management in the meanwhile - Dr Prakash A Mody and his immediate family I guess is in fairly effective control of the voting stock, with family entities controlling more than 5% each of the voting stock holding some 43.6% of the outstanding capital base. Collectively however, the promoter and promoter groups hold 48.7% of the outstanding equity. Quite some bit of the promoter held capital is held by corporate entities.

A multipronged operation

The company states that it is primarily a dosage formulations enterprise and manufactures a wide range of pharmaceutical formulations. What it has not stated is that it also buys finished goods on a large scale. The value of finished goods purchased and debited to the profit and loss (P&L) account totes up to some 13% of net product sales, same as previously. It goes on to add that the company has a strong presence in niche therapy areas of cardiology, neurology and anti-infectives. Cardiology continues to be the dominant segment of the company with the three mentioned segments accounting to 75% of the company's revenues. It has seven manufacturing units within the country and also boasts five subsidiary locations based out of South Africa, the UK, USA, Brasil, and Ireland. To round up its show of strength it has representative offices in the Ukraine, Russia and Ghana.

So what has the company got to show for its efforts, and from its spread of operations? The brief snapshot of the company's financials shows that the top-line has shown a consistent increase in total revenues each year in the last five accounting years. But the onward journey of the 'profit before interest depreciation and taxes' has not been as lustrous with the respective figures in each year waxing and waning in no set pattern. In 2007-08 the Profit before Interest, Depreciation & Taxes (PBIDT) was Rs 1.1 bn growing to a high of Rs 1.9 bn in 2009-10 and then falling sharply to Rs 1.4 bn in the latest accounting year. With borrowings being maintained on the fringes, the interest charges are only a flea bite of sorts, and after depreciation provision, the pre-tax profit too does a jig of its own. The company resorts to quite some tax planning it appears, given that the tax provision ranges from a low of 11% in 2007-08 to a higher 21% in the latest accounting year. So where is the dampener effect coming in from in the fluctuating profit level?

How the revenues stack up

The 'sales excluding other income' and the 'total income' grew sluggishly by 36% each from the base year 2007-08 in contrast to the overall growth in expenses. Total income grew to Rs 8.17 bn. The significant factor to be noted in the income equation is that exports as a percentage of all revenues increased from around 18% in the base year to 28% in the latest year. But it was unable to keep a tab on three other major expense items. R&D expenses rocketed by 76% to Rs 379 m, staff costs by 70% to Rs 1 bn, and other expenses grew 58% to Rs 2.4 bn. Cumulatively the company has spent close to Rs 1.5 bn on revenue R&D in the last five years - excluding that is any sums which may have been debited to capital account. The spending on Research & Development capital assets is a further Rs. 623 m. That makes for a cumulative total of Rs 2.1 bn. However, if this spending has led to any significant gains to the company, it does not quite appear to be showing up in the P&L statement as yet. The sharp increase in staff costs would imply that employee numbers too have accelerated. The company states that it presently employs more than 4,000 hands. In all probability the biggest bugbear that the company faces is in turning in an adequate margin on exports. One will never get to know the margins that companies extract on export earnings as the law does not mandate a separate accounting for export incomes and expenses. However the export benefits account for a trifling Rs 52 m in the latest accounting statement.

Besides, the company appears to be adding quite some value to traded goods on sale. It would appear from a cursory examination of the figures available on the purchase/ sale of traded goods, that the company is realising double the value on sale. It is not known what other expenses the company incurs on sale but the gross margin on sale is 100% - period. In 2011-12 the gross margin was Rs 1 bn, as was the margin realisation on sale in the preceding year. (Wonder just who the company buys the finished goods stocks from which give it such humungous margins!) However, such a value addition in turn further depletes the margin that it realises on manufactured goods. Further, it may not be out of place to state here that the 'other income' amounted to a not insignificant 9% of pre-tax profit in 2011-12 against a much lower 5.6% previously. Almost 45% of the 'other income' in the latter year comprised of forex gains - against a much lower percentage contribution from this source in the preceding year.

Some debilitating issues

There are other seemingly debilitating factors too. The gross block at end March 2012 consisting of both tangible and intangible assets amounted to Rs 5.6 bn as against Rs 5 bn previously. Separately there is the capital work in progress of Rs 1.1 bn against Rs 629 m previously. Now juxtapose the gross block figures with the revenues accrued from sales of products - net of excise. The revenue figures read as Rs 8 bn against Rs 7.6 bn previously. That is to say the gross block (excluding capital work in progress) to turnover ratio amounts to 1.42 times against a marginally higher 1.52 times previously. Does this amount to a low capital churning ratio? Or take the working capital management as represented by the year- end figures. It boasted gross current assets of Rs 4.1 bn against Rs 4 bn previously. Compare it to the corresponding current liabilities figures of Rs 2.2 bn and Rs 1.7 bn respectively. There appears to be a considerable mismatch here in the sense that there is a lot of tying up of working capital finances. However, the vast bulk of the current assets consist of inventories and book debts in either year. Also, the company appears unable to get the desired traction on the trade payables front. To a small extent the high trade receivables can be attributed to the siblings. I use the word small here only because the total sales affected to the siblings is relatively small given the overall revenues accruing from the sale of goods. In 2010-11 it sold goods worth Rs 235 m to its siblings, but the trade dues at year end amounted to Rs 197 m. It gets even more hilarious in the following year. The respective figures were Rs 306 m and Rs 315 m! The trade dues in the latter year are in excess of the revenues! This act of benevolence appears to have been extended to only two companies -one which accounts for its income in pounds sterling, and one sibling operating out of the States. Separately, there are guarantees advanced on behalf of the siblings by the parent.

There is another non revenue generator too in the assets schedule. This refers to the share capital investments that it has affected in other group companies. It gets no dividends for the outlays that it has made - but there are unfortunately valid enough reasons for this state of affairs. This non revenue generation however does not take into account any other pecuniary benefits accruing to the parent as a result of other inter-se transactions with the siblings. The company boasts 'non-current investments' of Rs 916 m - which is almost completely invested in its siblings. It has equity stakes in five siblings to the tune of Rs 800 m - on which it has made a provision of Rs 53 m. It also holds preference shares valued at Rs 116 m in one sibling. (Separately it has 'current investments' in debt instruments valued at Rs 145 m). As stated earlier it did not realise a dime in dividend income from its investments in 2010-11 or in 2011-12 but the stated purpose of these investments is obviously quite different. The holding in debt instruments led to a realisation of short term gains from the purchase/ sale of these instruments.

Cash flow management on even keel

Whatever may be the several minor irritants, the cash flow statement appears to show that the company is sort of on an 'all systems go' mode. The company generated positive cash of Rs 1.3 bn from operations and was thus able to spare Rs 1 bn for ploughing into its gross block. With the company also generating cash from the purchase/sale of investments it was able to plough a slice over Rs 140 m into its siblings. But in effect this led to a peculiar and avoidable situation. It had to borrow short term moneys to the tune of Rs 162 m to part finance the interest charges that it paid out and the dividend that was distributed to its shareholders. This last bit does not quite gel.

The gang of five

As stated earlier the company boasts of five siblings. Each one of them is cent percent owned by the parent. Individually and collectively they appear to be a bunch of non-performers and then some more. At least this is one's understanding of the state of affairs from the brief financials of these worthies which has been appended to the annual report. All the five have negative reserves and two of the five - Unichem Brasil, and Unichem USA have negative reserves which is almost equal to their paid up capital. The Brasilian venture has a paid up capital of Rs 266 m and negative reserves of Rs 233 m with zilch turnover to boot, while the American outfit has negative reserves of Rs 268 m on a paid up capital of Rs 295 m and a turnover of Rs 250 m. Each one of the five has shown a pre-tax loss for the year, with the Brasilian unit reporting the highest pre-tax loss of Rs 71 m. The company which has its currency denominated in pounds sterling and is called Niche Generics generated the highest revenues at Rs 793 m but reported a marginal loss of Rs 15 m. Second in line - revenue wise - was the American venture ringing up sales of Rs 250 m and a pre-tax loss of Rs 34 m. None of the other three has anything to show on the revenue front. The state of affairs is about as befuddling as it can get.

Interestingly enough the parent has affected sales of goods to Niche Generics and to Unichem Pharma USA. But both these companies have themselves generated revenues far in excess of the purchases that they have affected from their parent. To put matters in perspective the parent sold goods worth Rs 125 m to Niche, but Niche in turn affected sales of Rs 793 m on its own. Quite obviously, then, it is also purchasing pharma goods from other third party sources too for resale. Ditto is the situation for the American sibling. There also appears to be no mention whatsoever of what plans the management of the parent has in trying to turn matters favourably for these unfortunate non entities. It also does no good to the brand equity of the promoters.

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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2 Responses to "Unichem: Profitability waxing and waning"


Dec 29, 2012

information is very informative.I am holding few shares of company, i have to rethink over my holding.


Satish Amin

Dec 14, 2012

Interesting and at the same time informative. Since it is completing golden jubliee feel the management may offer somehthing to the shareholders. Appreciate if there is updating of information at regular intervals.

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