It is of course nice to know that the group has a superannuation policy in place. Well if it has one, then group company United Spirits appears to be blissfully unaware of it, or, it has a separate superannuation policy of its own. For, it has several senior staff who are pushing 70 years of age.
The hormone ingredient
It is indeed ironic that the very units which provide the vital hormone ingredient for food production are themselves in dire need of resuscitation. One reason for this is that several fertilizer units have been royally rogered by the very managements that germinated them. The notable examples include the many public sector and joint sector fertilizer units, and not forgetting SPIC (Southern Petrochemical Industries Corporation) and FACT (Fertilizers and Chemicals Travancore.) The more vexatious issue today is the fertilizer subsidy scheme which was originally invoked as a dual move, to counter the high cost of setting up new fertilizer units on the one hand, and to provide farmers with subsidized inputs on the other. (The concept of the subsidy scheme was to reimburse manufacturers for the retention price at which the fertilizer is sold, in conjunction with a pre-determined return on the capital employed.) A well considered move at the time of its introduction, but it has over the years been misused by all concerned, and is more of a millstone round the government's neck. Today this scheme has become a political hot potato for any party in power at the Centre, and a simultaneous drain on the resources of the exchequer.
Running to stand still
MCF is another instance of a company within the industry which today has to perform a jig just to stand still. Chronologically speaking it is some 43 years old and has very little to show for it, and that includes going back to the days when it was a satrap of the Karnataka government. (The company has never made even one bonus issue offering to its shareholders in its checkered history.) Conceived as a joint sector project jointly with Rallis India, it metamorphosed over time as a pure play PSU unit, till the then state government under the Chief Ministership of Mr. Veerendra Patil, in its wisdom saw value in hiving off the company to the UB Group. Other than making the point that the UB Group is a 'diversified' entity, the fertilizer business has no synergy whatsoever with the main business focus of the current owners, and how it dovetails into the group's plans is beyond comprehension - barring of course the large unutilized land bank that MCF holds.
Having to make do with what it is, MCF today chugs along at its own measured pace, though the latest directors' report states that FY10 has been a year of records. It achieved record sales of 1 m tonnes of fertilizers, highest ever sales of phosphates, the highest ever production of DAP and NP, and the highest ever profit after tax of Rs 565 m to boot. (Record net profit alright, but from the available stats in the annual report, what is left unsaid is that the profit before tax at 4.1% of net sales including other income, is lower than the 5.9% that it achieved as far back as in the year FY01!) Further, from the available details, the total tonnage of fertilizer sold appears to be 950,000 tonnes against 810,000 tons in the preceding year, or just shy of the 1 m ton mark. Net overall sales for the year however took a dive to Rs 20.7 bn from Rs 24.7 bn in the preceding year due to lower raw material input costs and consequently lower sale prices. The drop in sales is despite substantially higher imports of finished goods of DAP (di-ammonium phosphate), MOP (containing 60% potash) amounting to Rs 4.4 bn (Rs 2.4 bn), and the purchase of granulated fertilizers, and a ubiquitous item called 'Others' together amounting to Rs 872 m (Rs 878 m), for resale. Whether the latter two are also a part of the import basket is not readily known. Remarkably enough the company's production of urea in either year at 3,79,500 metric tons is the same identical quantity, and this production tonnage also matches with its licensed and installed capacities! Talk about achieving perfection.
Record profits?
The company's claim of record profits is not quite tenable. There is a smokescreen at play here. In reality the company recorded substantially lower profits than in the preceding year. To start with how the company accounts for its profits is in itself a quirky exercise. For example as stated earlier the resale of purchased finished goods was substantially higher than in the preceding year. Purely going on the basis of the purchase and sale figures per unit value, the company would have made a gross profit of Rs 630 m against Rs 590 m in the preceding year. Well to start with why did it resort to a substantial increase in imports to eke out a marginal increase in gross profits? What profit the company would have made at the net level from this exercise is impossible to tabulate, as the proportionate marketing costs, the transport costs, the interest costs, and the other administrative costs are inestimable. But presumably it made some money on this purchase/resale.
But on the other hand, higher imports infer much higher risks too, in today's world, especially on the forex calls that companies take, for whatever blessed reason. And getting a forex call right is about as easy as winning at the gaming tables. It is a game of pure chance. And for MCF the stakes are particularly high. In FY10 the company imported, going by one estimate, raw materials and finished goods worth Rs 13 bn against Rs 14.7 bn in the preceding year. (Different schedules give totally different values for the goods that it imports - but more on that later.) Quite apparently the company took a position in the forex front in both the years for reasons best known to it. But the problem is that in FY09, the company lost Rs 729 m in the process, after being caught in the wrong end of the call, against a gain of Rs 316 m in FY10. (In other words there was a net turnaround on this count alone at the bottom-line level to the tune of Rs 1 bn plus in FY10.)
Extraordinary incomes/ expenses
Such forex gains or losses are extraordinary in nature, in the sense that the outcome cannot be predicted, and have no real bearing on the operating efficiency of the unit. What is more, in the preceding year the company also sold/provided for diminution in value of its fertilizer bonds and took another whack of Rs 356 m, against a write off on this count of Rs 43 m in the latter year. The book value of the bonds is shown as Rs 1.5 bn in the preceding year end, and booking a loss of Rs 400 m on this book value is not small change. (In the process however the company reduced debt at year end to Rs 982 m from Rs 4 bn in the preceding year.) This is another extraordinary item in the sense that it is not of a recurring nature. In other words taking into account both these debits, the company was out of pocket to the tune of Rs 1.1 bn in FY09. The company also separately books losses on assets sold or discarded (the assets are apparently of vintage value), but then, this is a separate issue.
If these extraordinary costs/ gains on account of forex and sales of fertilizer bonds are neutered from the expense side of the P&L account for either year, then one will end up with the ridiculous situation of the company actually recording a substantially higher pre-tax profit of Rs 1.5 bn in FY09, against a pretax profit of Rs 571 m in FY10. This is absurd. On the one hand we have the management crowing about record production, record volume sales, and record profits etc, and add to this the large imports of finished stocks for resale, and the company actually makes less money in the bargain. This is a no brainer. (Granted that managements perforce have to present the sunny side of an enterprise, but that does not mean going overboard in the process.)
Complex accounting exercise
Even the accounting for its expenses etc appears to be a complex exercise. One schedule says that the CIF (Cost, Insurance and Freight) value of its raw material imports is Rs 3.9 bn, while another schedule says the value of imported raw materials is Rs 9.1 bn. How can there such a big difference in the two figures. (For the preceding year the figures are Rs 8.1 bn and Rs 13.3 bn.) There appears to be some mismatch in the finished goods import schedules too. And, from the cash flow that it has generated, the management has been kind enough to spend a little over Rs 1 bn in the last two years in replenishing the gross block. It has however not led to any visible increase in its operational efficiencies for sure.
Since it is de-rigueur for corporate houses to boast a few subsidiaries, MCF too has an offshoot sporting the name, MCF International, with a paid up capital base of Rs 500,000. Not surprisingly it is making heavy weather. From the sketchy details that the company has provided, this sibling has made a loss before taxation of Rs 28 m on a turnover of Rs 121 m in FY10. The after tax loss is slightly more lustrous at Rs 29 m. The quantum of its negative net worth is however not stated. And it had total liabilities of Rs 25 m. The latter figure is a bit puzzling because as per the parent's annual report, the total outstanding at year end from the sibling, being loans advanced to it, was Rs 79 m (Rs 12 m). This loan element does not appear to feature as a liability in the minimal details of the accounts furnished by the sibling.
All in all it is another insipid performance.
I DO NOT HOLD ANY SHARES IN THIS COMPANY, EITHER DIRECTLY, OR UNDER NON DISCRETIONARY PORTFOLIO
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.
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