As part of a new initiative we will review annual reports of companies. Annual reports of some companies are voluminous and lot of the material can be skimmed or skipped. We will highlight the important sections that one should look at while reading annual reports under this series.
We start with reviewing the annual report of Balkrishna Industries (BKT), manufacturer of OHT (off highway tires).
First: Read the Annual Report Here.
Director’s Report and Management Discussion and Analysis (MDA)
Companies usually have two separate sections for the director’s report and the MDA, however in the case of BKT these sections have been merged. Director’s report usually gives a snapshot of the financial performance of the company for the current year and brief commentary for the same.
The MDA section is very helpful. Some of the important things that companies discuss in this section are industry structure, important developments that the company is undertaking, outlook for the following year, opportunities, threats, risks and concerns. Some of the interesting things that we came across in the BKT annual report are:
What They Do:
Important information one can gather from the above is the nature of the business “large varieties low volume segment”, companies need to maintain large no of SKUs. Meaning, you can’t just create a tyre that goes on a 13/15 inch rim, you might need vastly different widths, rim sizes, treads, weight etc.
Also major markets for the companies products is abroad (developed markets), And segments – agricultural, industrial, construction and mining. Growth rate of the overall industry – 4-5% in this case, one can further check what is the growth rate of the company – is it above or below the industry growth rate and investigate the reasons for the same.
Company has undertaken a carbon black project, this is used as raw material for manufacturing tyres. 27-30% of the raw material cost is carbon black.
Carbon black is a very important part of tyre manufacturing – it is literally what makes tyres black, and having to procure it externally adds time and cost (and cuts margins) from the tyre making process. With BKT seeing this, they want to push their own sourcing for Carbon Black – so that efficiency can be increased over time.
Outlook for the current year 2018-19
The business environment is challenging however the company is taking steps to continue growth in its business – deeper penetration in existing markets, outreach to OEMs (company derives majority of its sales from the replacement market), increasing product range.
Opportunities and Threats that the company faces
The company see’s at opportunity in the earthmoving and mining segment. BKT derives about 65% of its revenues from the agricultural tyre segment, however 65% of the industry is the industrial tyre segment (construction, mining, earthmoving) the industry is estimated to be $15 billion. There is also a shift seen from the bias to the radial segment, 37% of tyres currently manufactured by BKT are radial.
Some of risks that the company faces are fluctuation in raw material prices – major raw materials required to manufacture tyres are natural rubber, synthetic rubber and carbon black – these form 70-75% of the raw material. Foreign exchange (FX) risk – majority of the raw material of the company is imported, however since 85% of the companies revenues are generated through exports the company enjoys a natural hedge.
Financial snapshot for the current and previous year for BKT are as below
On a consolidated basis revenues have increased by 18% and profits by 3%. We will look at the financial statements in detail later in the post.
There is an increase in promoter shareholding at the end of FY18 as compared to the previous year. Promoters hold 58.30% of the company. None of the promoter shares are pledged.
Financial institutions – mutual funds and FIIs hold 28.96% as compared to 31.52% in the previous year. Non institutions – Individuals and bodies corporates hold 12.74% as compared to 14.11% in the previous year. The company issued a bonus (1:1) on 27th December, 2017.
Mutual funds which own shares in the company are – HDFC, Franklin Templeton, Invesco, ICICI and SBI. Amansa holdings run by veteran fund manager Aakash Prakash owns 28.31 lakh shares in the company translating to 1.46% stake.
Remuneration of directors and key managerial personnel (KMP)
It is very important to look at the compensation of directors and KMP of the company and compare it with the ceiling as per the companies act,2013.
The managing director and joint managing director take home Rs 63.50 Cr as salaries and commissions, this is below the ceiling limit of Rs 113 Cr or 10% of the net profits of the company. The net profits of the company for FY18 were Rs 736 Cr, however net profits are calculated as per section 198 of the companies act,2013 and the ceiling limit is arrived at. Other independent directors were paid Rs 12 lakhs towards board meetings. Mr Basant Bansal, CFO of the company was paid Rs 1.38 Crs as salaries and perquisites.
While 63 cr. looks like a lot of money, it’s actually very small as a percentage of the net profits earned.
Comparison of remuneration of KMP with the median remuneration of employees of the company are as below.
The average remuneration of employees works out to Rs 4 lakhs and the company had 2,712 employees as on 31st March, 2018.
Below is the breakup of the debt at the beginning and end of the financial year. Companies have been reporting their debt positions in this format since the last 2-3 years.
The company has reduced substantial amount of debt during the year, it has retired debt to the extent of Rs 526 Cr during the year. Total debt outstanding at the end of FY18 was Rs 836 Cr.
In BKT’s case, it is useful to look at past reports. You will understand that the bulk of the debt was taken to expand (double) capacity a couple years back, and they have used most of their cash flow to retire that debt as the capacity has come into use.
It is very important to go through the auditor’s report on the financial statements of the company. In the past auditor’s have made observations in certain companies which were red flags enough for the investor to sit up and take action. This section is not voluminous and investors can quickly go through this section.
Below is the opinion of the auditor’s for the financials of BKT
The auditor’s report is satisfactory, however they haven’t audited the financial statements of the 5 foreign subsidiaries.
Consolidated Financial Statements
BKT has 7 subsidiaries and financials off those companies are merged with the standalone to present the consolidated financial statements. Before we look at the consolidated balance sheet, profit and loss and cash flow statement of the company, details of the subsidiaries are as below.
The net profit of the 6 subsidiaries is Rs 1.46 Crs.
Some of our observations from the above balance sheet are as below
- Fixed assets form 50% of the assets of the company. Additions to property plant and equipment (PPE) have been to the tune of Rs 323 Cr during the year
- Non current investments and current investments add up to Rs 1,110 Cr, 19% of the assets of the company. These are investments in financial instruments. Put another way, this is equivalent to cash. These can be used in the future to reduce debt or undertake CAPEX
- Jump of Rs 100 Crs seen in other non current assets, these are primarily capital advances (advances made to procure equipment) for Rs 183 Crs
- Inventories have increased by 30% and stand at Rs 619 Cr at the end of FY18. Raw materials and stock on trade have lead to this increase
- Other current assets have increased by 74% and stand at Rs 299 Cr. Advance payment to suppliers is Rs 141 Cr and Rs 153 Cr are taxes and receivables
- Owner’s equity funds 69% of the assets of the company
- Drastic reduction seen in borrowings, total borrowings at the end of the year Rs 867 Crs as compared to Rs 1,391 Crs in the previous year. Borrowings are also recorded under other financial liabilities as “current maturities of long term debt”
- (You might be confused by that: What the company owes is not just the “borrowings” headings in Current or Non-Current liabilities. That is just one part. The other part is the debt you have to repay, which you borrowed a long time back – and that will reflect in “Other financial liabilities” in the Current Liabilities section)
- Company has a net cash position, meaning it can retire all its debt with the investments and cash that it has. The net cash that the company has is Rs 269 Cr (1136-867)
- Receivables and payables have increased by 16% and 9% respectively
Profit and Loss
Some of our observations from the above profit and loss are as below
- Revenues have increased by 18% at Rs 4,460 Crs. This was mainly volume growth – sales of 1,99,213 MT versus 1,72,419 MT in FY17, increase of 16%
- 34% increase in other income, majority of this is contributed by net gain on FX transaction and translation, gains recored during the year were Rs 264 Cr
- Raw material costs have seen a substantial jump of 38%, this could be due to increase in specific raw materials or raw materials across the board. Management had commented on the carbon black situation in the MDA section.
- Operating profits or EBIT has increased by 5%, operating margins at 25% as compared to 29% in the previous year. This is due to the combination of increase in raw material prices and fixed costs like employee and other expenses
- Depreciation has increased by 2%, there is no major CAPEX that the company has undertaken during the year
- Interest costs have fallen by 37% at Rs 14 Crs. Company has substantially reduced debt during the year
- Net profits before adjustments at Rs 735 Crs versus Rs 717 Crs in the previous year, increase of 3% over the previous year. PAT margins at 16% versus 19% in the previous year. Effective tax rate (tax expenses/profit before tax) a tad higher at 34% versus 32% in the previous year
- Adjustments have been made to the net profit to arrive at the total comprehensive income. These majorly come from hedging activities
- If you look at the EBIDTA margins (operating income minus operating expenses) you will find that they continue to command massive margins of 25%+ despite an increase in their raw material cost. That goes to show their higher efficiencies and/or their ability to price a product well. In comparison, margins at regular tyre companies such as Ceat or MRF are only 10% to 15%.
Cash Flow Statement
The company has generated cash flow from operations (CFO) of Rs 750 Cr, it is important to compare the CFO withe net profits for the year. The company posted net profits of Rs 736 Cr before adjustments. This is in line with the CFO that the company has recorded, the reason we compare the CFO with the net profits is to check if the company is able to convert its accounting profits (recorded on the P&L) to cash. CFOs are also called as the cash profits.
CAPEX undertaken during the year is Rs 420 Cr, this is majorly funded by the sale of investments that the company has on its books. Company realized net amount of Rs 305 Cr by the sale of investments. The net cash flow from investing activities is Rs 92 Cr, this can be easily met by the CFO.
The free cash flow which is difference between the cash flow from operations and cash flow from investing is Rs 661 Cr (753-92). Positive free cash flow can be used to retire debt, pay dividends, do buybacks. BKT has retired debt to the tune of Rs 701 Cr. Company has also paid dividends to the tune of Rs 121 Cr.
Related Party Transactions (RPT)
One must also look at the RPT to check if things like products being sold, raw material purchase, rent paid, royalty payments are carried out related parties. Below are the details of RPT of BKT
One can see that there are no significant RPT for the company.
Contingent liabilities are not recored in the financial statements, they are off balance sheet items and are reported separately. These may be claims made against the company which are under dispute. While these may not materialise in the immediate future, it is a good practice to check the quantum of these liabilities. Below are contingent liabilities of BKT
One can observe that the biggest item in the above table is corporate guarantees given by the group to the president of India to the tune of Rs 1814 Crs. While we do not have details of the same, these look like guarantees that the company has to make as part of running its business. There are disputed claims to the tune of Rs 65 Cr and these have reduced from the last year.
We hope that readers have got important insights of BKT after going through the above review. Many investors make their investing decisions without reading the annual report, however going through annual reports of companies is very important and a starting point of making good investing decisions. We would also recommend going through annual reports of competitors and global players operating in the same industry to get a better understanding of the business.
NOTE: Please do not consider this article as a recommendation, It is purely for informative purpose only. Authors may have positions in the stocks mentioned, so consider our analysis biased. We own the stock in our PMS. There is no commercial relationship between Capitalmind and the companies mentioned in this analysis.
Our Premium Long Term Portfolio is at https://capitalmind.in/
Our Premium Momentum Portfolio 2.1 is at https://capitalmind.in/
Our Premium DivYield Portfolio is at https://capitalmind.in/
Our Premium EV Portfolio is at https://capitalmind.in/