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Tuesday, August 26 1997

Mark to Market -- Kirloskar Pneumatic: diversions on hold

Aaron Chaze

August 25: Throughout much of last year the management of Kirloskar Pneumatic Company Ltd (KPCL) made a big deal about how the company was planning to make a debut into what they hoped would be an infrastructure project (possibly through a subsidiary), ie transporting goods on behalf of companies from railheads to interior destinations through a system of road railers (something similar to what the Container Corporation of India does), except that KPCL would not warehouse the goods at all but merely move it from the railhead to an urban destination. And all this was supposed to cost the company an initial investment of Rs 125 crore for which they had sounded out ICICI and others for debt funds and ECBs. KPCL was also reportedly interested in putting in Rs 40 crore by way of equity into the project and the financial structuring was supposed to have been done by March 1997.

Despite all this hullabaloo over the last one year, the annual report to shareholders for the year 1996-97 made absolutely no mention of this project or anything even remotely connected with it. And at the same time, despite an unspectacular performance for the year, the KPCL stock has been a good performer on the stock market, after the results were announced. Perhaps the 20 per cent dividend declared for 1996-97 provided a good enough yield of over 12 per cent at the then prevailing price of Rs 17; making it attractive to arbitraguers.

It is difficult to understand how a company that earns a paltry net profit of Rs 6.77 crore (other income - Rs 6.92 crore) on gross revenues of Rs 210 crore could finance such a large project even if it was spread over two or three years considering that it is already highly leveraged (D/E of 1.3:1). KPCL would find it very difficult to pay the Rs 40 crore as its equity contribution as it does not have the required balance sheet strength. Its free cash flows are fully reinvested in its own business.

The company has obviously shelved the project or at least deferred it. Its core business is in air and gas compressors, pneumatic tools, gears for varied industrial and marine applications, power transmission equipment and airconditioning packages, so it was difficult to imagine what synergies it saw in what is essentially a transportation business.

Its own business is fast growing and though very superior product-wise, its finances need a lot of attention. Operating margins have stagnated at 7-8 per cent. Longer working capital cycles and lower margins have worked in pulling down the RoE to a pathetic 11.5 per cent. Besides, the company's auditors have chastised the management for non-provision of Rs 18 crore towards disputed excise claims which could have serious repercussions if it fructifies.

Hopes for a better valuation

The Birla Yamaha Ltd stock kept track of the market's recent moves, including the recent fall. The stock dropped by 15.5 per cent in just four days. The company as such operates a small but reasonably profitable business. But that is not what the market discounted during the stocks move upwards. Following the hike in stake in Shriram Honda (BYL's competitor) by Honda Motors of Japan to 51 per cent, the expectation was that the same would happen in BYL. Hence the demand for the stock.

The news that Yamaha of Japan will hike its stake in the company through a preferential offer of shares to 29 per cent could rekindle the optimism of a majority stake passing into the hands of the Japanese, even though the Yash Birla group will now hold 40 per cent of the expanded equity.

After all there has been a precedence within the Yash Birla group for making strategic exits from companies with strong overseas partners. Birla 3M is a case in point, where it turned its controlling stake into an investment holding, reaping the benefit of a higher market discounting in the process (Birla 3M commands a p/e of 88 times at present compared with 7 times for BYL). History could repeat itself with BYL.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.

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