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International Combustion: Needs to get firing - Outside View by Luke Verghese

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International Combustion: Needs to get firing
Dec 30, 2011

A fuddy duddy company run by a very complacent management, or so it would appear.

Far out but not far enough

For a 75 old manufacturing company it really hasn't gotten all that far really.

Presently a manufacturer of mineral, and material processing equipment, and gear box and geared motor drive systems, it logged in a gross turnover of Rs 1.2 bn from Rs 1 bn recorded in the preceding year. The pre-tax profit on the other hand fell to Rs 148 m from Rs 174 m previously. But I will elaborate on this point later on in this copy. And since the platinum jubilee year performance did not warrant any celebration of any sorts, the year went by like any other year in its life. The ten year financial statistics shows that the company registered an almost steady increase in net sales over the ten years barring one year that is. But the same was not necessarily true of the profitability front. The pre-tax profit has had a slightly erratic ride of sorts, over the last three accounting years.

International Combustion germinated life in India as a subsidiary of International Combustion of England. Over time the English company was apparently acquired by Asea Brown Boveri (ABB). At some point of time also the Indian operations passed into the hands of the Kolkata based Bagaria family. The family presently owns some 53% of the piddling voting stock of Rs 24 m, 2.4 m shares of Rs 10 each. That does not leave for much floating stock.

Its product line

The company makes and sells a variety of end products, but the company clubs it under two major heads - Mineral and Material handling equipment, and gear box and gear motors. The individual capacities of the products on offer appear rather apologetic, with the installed capacities of majority of the products way below the licensed capacities. The production of each and every item in turn is way below the installed capacities. Value wise the two largest manufactured end products on offer are magnetic vibrators and feeders, and gears. Of the first, it has a licensed capacity to make 1,644 nos; an installed capacity to make 600 nos, and it produced 494 nos. This item alone accounted for 29% of all sales in 2010-11.

Second in line was the sale of spares which brought in Rs 282 m of a neat 27% of the top-line. (In all probability this item had a more than disproportionate contribution to the bottom-line. But there is no way of getting to the figure, given the manner in which the company classifies spare part sales in the business reporting segment schedule). Next in the pecking order is Gear box and geared motors. Here the licensed and installed capacities match at 9,000 nos. But the production was limited to 7,923 nos. This item toted up 25% of sales. Together these three lines of business accounted for over 80% of all sales. Other items of sales which are of minor import are Mogensen sizer, and vibratory feeders, etc.

The competition

The company gets its moolah from the sale of items classified under material handling equipment. This line brought in a segment profit of 35% on sales. The sales of material handling equipment also accounted for 73% of all sales. The unit price realisation, on an average, was marginally higher than in the preceding year. But the drag on its resources emanated in the gear box segment. The segment profit here declined drastically to 8.5% from 17.5% previously, while it accounted for the balance rupee sales. This is inspite of the fact that the company sold 7,923 nos against 5,531 nos in the previous year-a volume increase of 43%. Apparently, given the standing costs the company decided to push more volumes inspite of decreasing margins to take on the competition. The unit price realisation per motor declined to Rs 30,050 on an average from Rs 39,800 previously.

The directors' report says that the company faces increasing competition in this line of business. The scene is not all that bad really. Trade debtors at year end accounted for 26% of all sales, but significantly there is no provision for doubtful debts at year end! This is swell! The company was also able to get buyers to cough up advance payments for experiencing the pleasure of buying what it has on offer. It is off-course impossible to get a fix on the price realisation that it could have obtained on spares given the complexities of arriving at even a ballpark figure - but it is fair to estimate that the sale of spares would have made the cash box jingle somewhat.

An oddball too

The company appears to be an oddball in several respects. The directors' report states that despite substantial increase in the inflow of orders, they could not be executed due to capacity constraints in its plants. The directors go on to state under the subhead “Future Outlook” that as a part of sustained efforts to attain growth through expansion of the product portfolio, the company has entered into a licence agreement with a Brazilian company to manufacture material handling equipment. Commercial production is expected to commence in the current year. The report further goes on to say that in the Bauer division various investments made by the company have significantly enhanced production capacity. The market for geared motors is large, and significant growth is expected in this area in the current and future years. With the above viewpoints in mind, the company has spent on paper Rs 151 m in the last two years on gross block updation. The total book value of the gross block at year end stood at Rs 528 m. That would make for a 40% addition to gross block in two years!

The ground realities however appear to be quite different to what is stated above. For starters, the management's comments on capacity constraints are not borne out in the schedules to the annual report. In the schedule of 'particulars in respect of goods manufactured' the production of all items, including the heavyweights is way below the installed capacities. So what capacity constraints is the company referring to please? The 'licence agreement' to manufacture material handling equipment would infer that the installed capacities would show a rise over that of the preceding year. But that is not to be. Further, the Bauer division is supposed to have enhanced its manufacturing capacities. Which manufacturing capacities is the directors' report referring to please? And what happened to the spending on capital assets for the last two years? This spending does not seem to have led to any enhanced capacities in the latter year.

The surplus cash management

The other oddity is the way it manages its surplus cash. As the company is currently unable or incapable of achieving more bang for the buck from its manufacturing facilities, the management has taken to making the funds sweat in other ways. The debt stands at Rs 83 m, up from Rs 73 m previously. The investments – all of it in liquid debt schemes stands at Rs 145 m, up from Rs 110 m previously. The cash balance at year end is however down to Rs 117 m from Rs 191 m previously. It also invested Rs 30 m in inter-corporate deposits during the year. What exactly is the benefit that the company obtains by juggling cash in this manner is not immediately evident, save the fact that other income from interest receipts and profit on redemption of investments brought in 17 m during the year. The interest payout on the other hand came to Rs 6.6 m. This is not taking into account any tax benefits that accrue on tax free receipts and the tax benefit available on interest paid out. The company during the year redeemed debt instruments worth Rs 43 m and booked a profit of Rs 3.3 m on this exercise.

If the management is really serious about taking on the competition and forging ahead, it has an abundance of dosh at its disposal, and this money is merely marking time at present. Besides, it has very low gearing. The company's share price in the secondary market is also ruling high relative to the Rs 10 face value of the share, but this is basically due to the lack of floating stock than any genuine investor demand. Besides the reserves and surplus at year end at Rs 730 m is many many times higher than the paid up equity of Rs 24 m. On paper that makes it pregnant for a prospective bonus offering. Fat chance of that happening though!

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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