Chemicals: ENGRO POLYMER AND CHEMICALS LIMITED - Analysis of Financial Statements Financial Year 2006 - 3Q Financial Year 2010

Engro was incorporated in 1965 and was formerly called Exxon Chemical Pakistan Limited until 1991 when Exxon decided to divest their fertiliser business on global basis and sold off its equity of 75% shares in the company. The group's principal activities are to manufacture, purchase and market fertilisers and it is the second largest urea producer in Pakistan with a market share of 19% which will reach 35% after its capacity comes online in 2010.
Engro has a number of subsidiaries which include Engro Foods Limited (EFL), Engro Vopak Terminal Limited (EVTL), Engro Energy Limited (EEL), Avanceon, Engro Polymer and Chemicals Limited (EPCL) and Engro Energy Limited (EEL). Engro operates through four segments namely, fertilisers, polymer, food and other operations.
Fertiliser segments: manufactures, purchases and markets fertilisers, polymer segments: manufactures, markets and sells poly vinyl chloride, PVC compounds and related chemicals, Food segment: manufactures, process and sells dairy food products and other operations segment includes independent power projects and engineering and automation business. The Group operates solely in Pakistan.
ENGRO POLYMER AND CHEMICALS LIMITED
Engro Polymer and Chemicals Limited (EPCL) is involved in the manufacturing, marketing and distribution of poly vinyl chloride (PVC). The company was established in 1997, and went into commercial production in December 1999. EPCL was formerly known as Engro Asahi Polymer and Chemicals Limited (EAPCL). Engro Asahi Chemical with an investment of US $80 million set-up 100,000 tons PVC plant at Port Qasim, (EAPCL) at the time of its formation was the only PVC manufacturer in the country. Engro Polymer & Chemicals Ltd (EPCL) has invested $250 million for enhancing its PVC production capacity by 50,000 metric tons through backward integration to 150,000 MT per annum by March 2009. The company is currently the market leader in PVC production and has a 76% market share which is expected to increase when the company's additional capacity comes online by the end of the second quarter of 2009. The company's major shareholding is with Engro Chemical Pakistan which has a shareholding of 56%, followed by International Finance Corporation which has a 14.6% shareholding and than by Mitsubishi Corporation which has an 11% shareholding.
RECENT RESULTS (3QFY10)
Sales were recorded at Rs 10,557 million as compared to Rs 8,215 million for 9MFY09, an increase of 28.5%. However, gross profit decreased by 17.3% due to hike in cost of sales. All other costs like administrative, marketing, distribution and financial increased quite rapidly pushing the company in the red. Company incurred a loss after tax of Rs 762.4 million during the first nine months of the year as compared to a loss after tax of Rs 18.6 million in 9MFY09.
This translated into a loss per share of Rs 1.23 as compared to a loss per share of Rs 0.03. Reasons for the loss is higher operating costs in the absence of economic benefits arising out of integrated operations caused by delay in VCM start up. As a result, the incremental fixed costs and financial charges could not be recovered. The company remained in breach of a loan agreement covenant at the end of 3QFY10 as the current ratio continued to be under pressure.
Vinyl Chloride Monomer (VCM) plant achieved commercial production in the month of September FY10. VCM scrubbers which were damaged during the fire incident in December FY09 were installed after refurbishment and successfully commissioned during August FY10. The VCM plant was shut down during August for maintenance. VCM production was 22K tons during 3QFY10 as compared to the plant's production capacity of 38K tons whereas the VCM production was 36K tons for 9MFY10. Highest level of VCM production of 9.4K tons was achieved during September FY10.
Poly Vinyl Chloride (PVC) production during the third quarter was 29Ktons as compared to 31K tons in 3Q 2009. The lower production was a result of limited availability of Vinyl Chloride Monomer (VCM) and plant shutdown for maintenance. PVC production for 9MFY10 was 80Ktons as compared to 91Ktons in 9MFY09.
Domestic PVC sales for 3QFY10 was 27K tons as compared to sale of 29K tons for the corresponding period last year. While domestic demand remained strong, decline in sales was due to production constraints and several customers had to import their requirements. Around 4.5K tons of resin was imported during the quarter due to earlier supply constraints.
International PVC prices showed an increasing trend from an average price of around USD 880 in July to USD 985 in September. This rise can be attributed mainly to the rise in feedstock prices and supply demand situation. Similarly, Ethylene prices rose from an average of USD 818 in July to USD 1000 in September.
Caustic Soda production for the quarter was 23Ktons as compared to 14K tons in 3QFY09. Total production for 9MFY10 was 67Ktons. Caustic soda sales remained strong during the quarter where domestic sales were 20Ktons for 3QFY10 and sales for 9MFY10 were 58K tons.
Most of Ethylene Di Chloride (EDC) produced was primarily used for the production of VCM. However, the surplus EDC of 10K tons was exported during the quarter through its subsidiary. A total of 33K tons of EDC were exported during 9MFY10 as compared to 16K tons during 9MFY09.
FINANCIAL PERFORMANCE (FY06-FY09)
The sales revenue of Engro Polymer has increased by 47% over last year. This increase in sales revenues is mainly attributed to growth of PVC sales and successful launch of caustic soda by the Company in FY09. During the year, 116K tons of PVC was produced against nameplate capacity of 150K tons per annum. Capacity utilisation of PVC plants remained low due to limited availability of Vinyl Chloride Monomer (VCM - a raw material in PVC production) as a result of delayed in-house production. VCM shortfall was partially fulfilled by procuring on spot basis from international market, however, given the tight demand-supply balance in the region, at times, VCM could not be timely arranged resulting in lower operating rate of the PVC plants. Nevertheless, domestic PVC sales of 119K tons in FY09 were the highest ever since the inception of the Company. This growth of more than 20% in domestic sales, over last year, was mainly attributable to the strong demand coming out of Government projects, increased usage of PVC pipes in agricultural sector and export of pipes and fittings to Afghanistan. The company also exported 10K tons of PVC during the year through its subsidiary, Engro Polymer Trading (Pvt.) Limited.
Another reason for higher sales revenue in FY09 was an increase in international PVC prices. PVC and VCM prices increased due to a surge in price of Ethylene attributable to high crude oil prices, coupled with a demand-supply gap in the region.
The Company's chlor-alkali plant came into commercial operation from August 1, 2009, which enabled production and successful launch of caustic soda by EPCL. A total of 32K tons was sold in the domestic market whereas 2K tons was exported through its subsidiary. Successful launch of Caustic soda was mainly attributable to high product quality supported by competitive pricing and an efficient distribution system.
During FY09, the profitability of EPCL showed an overall decreasing trend. The company incurred a loss after tax of Rs 232 million as compared to a profit after tax of Rs 353 million last year. The consolidated loss after tax was Rs 194 million as compared to consolidated profit after tax of Rs 350 million last year. The main reasons for the loss are attributable to incremental costs related to depreciation, financial charges and other fixed costs on account of expansion and back integration whereas full economic benefits of the integrated facility could not be attained as VCM plant had not come into commercial production. In particular, expansion projects included completion of 50K tons PVC expansion project on January 1, 2009 and commencement of commercial operations of Chlor-alkali, Ethylene Di Chloride & Power plants on August 1, 2009.
The gross profit margin of the company was 30.7% lower than last year. This was mainly due to a 47.45% increase in net sales as compared to just a 1.79% increase in gross profit. The profit margin of EPCL experienced a 144.5% declined mainly attributable to the loss experienced to the loss experienced by the Company during FY09.
Return on Assets and Return of Equity ratios of the Company also declined by 153% and 168%, respectively, during FY09. ROA decreased for two reasons - loss experienced, and a 23.4% increase in total asset base as a result of capacity expansion.
The current ratio of the EPCL fell by 9.7%; whereas, the quick ratio increased by 5.44% in FY09 as compared to last year. From this trend we can conclude that the liquidity of the company shows a mixed trend. This drop in current ratio of the company is attributed to a 73.03% increase in current liabilities during the year as compared to a 56% increase in current assets. While a decline in current ratio may predict deterioration of the short-term solvency of the company, the improvement of the Company's quick ratio suggests that EPCL's short-term creditors are adequately covered by current assets other than inventory.
EPCL's asset management ratios depict a mixed trend in FY09. The total assets of the Company increased by Rs 4,277 million during the year mainly due to the expansion and back integration project. This 23.4% increase in total assets translated into a 47% increase in sales for the year FY09 and showed that the Company generated sufficient business given its investment in total assets. For similar reasons, the fixed assets turnover ratio of the Company also exhibited a 22.5% increase, showing that EPCL has started utilising its fixed assets more intensively. The inventory turnover of the company has reduced by 14% from 57 to 49 days. This means that EPCL's inventory is turned over fewer times in FY09 as compared to FY08, which would suggest that the company is holding excessive stocks of inventory. Similarly, the increase in EPCL's days sales outstanding from 4.8 to 5.4 days shows that the company's ability to collect its credit sales in a timely manner has somewhat reduced. However, the company's operating cycle has improved by 35.32%.
EPCL's debt management ratios have declined in FY09. During the year, the Company entered into interest rate swap agreements with banks to hedge its interest rate exposure on floating rate borrowing from International Finance Corporation (IFC) for an amount of US $40 million. The swaps are effective for the period starting from December 15, 2008 and ending on June 15, 2017. The fair value of the interest rate swaps as at December 31, 2009 amounted to Rs 20 million. The Company also entered into a Syndicate Term Finance Agreement with a consortium of local banks for Rs 1,500,000. As a result the total debt of the Company increased by 38.3% over last year and the debt-to-asset ratio of the company increased by 12.06% over last year. This shows that the Company has increased its use of debt financing. The interest coverage ratio of EPCL has decreased by 94.3% from 25.32 to 1.44. This shows that EPCL is covering its interest charges by a low margin of safety, and the extent to which its operating income can decline before it is unable to meet its annual interest costs has greatly reduced. The long-term debt-to-equity ratio of the Company has also risen by 16.4% from 0.55 to 0.64 over last year.
Engro Polymer's market value ratios showed an overall decline during FY09. The company's earnings per share, price/earnings ratio, dividend per share and book value per share all declined by 166%, 154%, 100%, and 3.14%, respectively. One of the reasons for this decrease is that loss per share for the year was Rs 0.45 whereas earning per share for last year was Rs 0.68. In view of the loss made by the Company during the year and delay in VCM plant start-up, the Board of Directors did not announce any dividend. Decline in EPCL's market ratios can have a dampening effect on investor confidence. The Company needs to take action to correct its asset management problems and improve its leverage position, in order to strengthen investor confidence and improve all its financial ratios.
FUTURE OUTLOOK
International prices are forecasted to be improving due to global demand supply situation. PVC prices have also moved higher and are expected to remain stable at these levels. International Caustic Soda prices are expected to increase during the 4QFY10.
PVC domestic demand is expected to remain slow during the coming quarter due to the liquidity crunch in the market and reduced government spending. Therefore, the company has initiated exports of PVC which provides good margins at the current time. Demand for caustic soda is expected to remain in line with the company's production.
The margins are expected to improve as the integrated facility operations smooth out. However, the profitability would depend on the productivity of the entire complex.
The company is expected to show a net loss at the end of FY10 due to the delayed commissioning of the VCM plant which has already resulted in a cumulative loss of Rs 762 million during 9MFY10.

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RATIOS

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PROFITABILITY                           2009      2008      2007      2006

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Gross profit margin                     9.96%     14.4%     15.9%    19.0%

Profit margin                          -2.00%      4.5%      7.0%     7.3%

Return on Common Equity                -3.64%      5.4%      8.1%    18.6%

Return on Assets                       -1.03%      1.9%      4.5%     8.9%

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LIQUIDITY RATIO                         2009      2008      2007      2006

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Current Ratio                           0.66      0.73      3.06      1.00

Quick Ratio                             0.32      0.30      2.45      0.43

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DEBT MANAGEMENT                         2009      2008      2007      2006

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Debt to Asset                           0.72      0.64      0.34      0.52

Interest Coverage Ratio                 1.44     25.32     22.25      14.3

Long Term Debt to Equity                0.64      0.55      0.21      0.10

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MARKET VALUE                            2009      2008      2007      2006

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Earning per share                      -0.45      0.68      1.64      2.14

Price earning ratio                    -2.51      4.66         -         -

Dividend per share                         0      0.54      2.10      1.85

Book value                             12.23     12.63     14.03     11.50

Number of shares issued (in '000)    520,000   520,000   444,000   178,000

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ASSET MANAGEMENT                        2009      2008      2007      2006

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Inventory Turnover (Days)              48.43     56.32     69.05     55.74

Days Sales Outstanding                  5.37      4.77      8.15     15.07

Operating Cycle                         7.18     11.10      6.20      5.60

Fixed Asset Turnover                    0.60      0.49      1.29      2.16

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COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
DISCLAIMER: No reliance should be placed on the [above information] by any one for making any financial, investment and business decision. The [above information] is general in nature and has not been prepared for any specific decision making process. [The newspaper] has not independently verified all of the [above information] and has relied on sources that have been deemed reliable in the past. Accordingly, the newspaper or any its staff or sources of information do not bear any liability or responsibility of any consequences for decisions or actions based on the [above information].
Copyright Business Recorder, 2010