Denim Mills: AZGARD NINE LIMITED - Analysis of Financial Statements Financial Year 2001 - Financial Year 2007
Azgard Nine Limited (ANL), formerly known as Legler Nafees Denim Mills Limited, was a joint venture between a leading European brand and a Pakistani manufacturer, Nafees Cotton Mills Ltd. Hence the company turned from fabric supplier to a composite spinning, weaving, dyeing and stitching unit engaged in the manufacturing of yarn, denim and denim products.
It is one of fully vertically integrated players in Pakistan's textiles sector largest producer and exporter of denim and denim products. It is a public limited company and listed on Karachi Stock Exchange in 1996. It currently operates under two business divisions: Textile Apparel Business and the Agrichemical Business.
THE TEXTILE APPAREL CHAIN Despite the prevailing energy crisis, higher mark-up rates, increase in minimum wages and the political change taking place in the country, ANL's textile apparel chain, spanning cotton yarn spinning, denim fabrics and garments, is the largest denim products business in the country.
The company's plans to balance modernise and rehabilitate (BMR) its textile chain with commitments to further emphasise on quality and service along with training of workforce to achieve the required skill levels and better machine efficiencies. The company is importing a generator having dual fuel facility which will improve the operational efficiencies and curtail its costs.
State Bank of Pakistan has permitted Azgard Nine to remit euro 23.758 million for an offshore acquisition of branded denim and garment business for acquisition of foreign company, of Farital AB which has 100 percent ownership of Montebello, a specialist in the global denim space. With significant investments in research and development and a global distribution network, it markets and sells many different types of special denim under its own registered trade mark brands with approximately 85 percent sales in the Pan European market.
This acquisition will provide ANL a strategic opportunity to boost its earnings through both volumetric growth and attainment of higher price levels. The key challenge in this regard is the expeditious migration of the cost base, thus capitalizing the opportunity and maximizing the margin improvement envisaged by the acquisition.
THE FERTILIZER/CHEMICALS BUSINESS In FY06, ANL acquired Pak American Fertilizers Ltd. (PAFL), the newest, lowest cost and most efficient urea manufacturing plant in the country. The company's agrichemicals business, through its 100% owned subsidiary PAFL, retains its position as the fifth largest urea manufacturer in the country with a urea and DAP market share of 7%.
PAFL has also started the fertilizer trading business by importing and selling phosphate fertilizers in the country. Its Tara brand, launched in January 2007, is focused urea product in the country. The company intends to further promote the brand by educating farmers about its benefits through local workshops followed by farm improvement programmes.
PAFL began its balancing modernizing and rehabilitation (BMR) of its ammonia and urea plants to enhance urea and ammonia capacity to 135% of nameplate capacity. The revamp is to be completed by mid 2009 with an estimated cost of US $55 million.
FINANCIAL PERFORMANCE (FY01-FY07) FY07 was another hallmark for Azgard Nine considering the growth in top line. The company posted net sales at Rs 6.63 billion showing a healthy increase of 36% over FY06. The 5-year CAGR of 32% in net sales is attributed to an extensive BMR and market exploration programme carried by ANL in the past few years.
Moreover, as a result of well-prepared sales network with foreign marketing offices and vertical integration of the textile production chain, the company experienced high acceptability of its premium products in the international markets. Both local and export sales registered an impressive 32% and 54% increases respectively, as evident from the gross sales break-up.
The local cotton price during FY07 averaged at Rs 3,000/maund from Rs 2,351 per maund in FY06, increasing about 28.0%. Adding to the predicament, the imported cotton consumption rate was charged at Rs 3,547/maund during H2'07 compared to Rs 3,435/maund in the corresponding period, while the textile exports also dwindled by 3 percent. However, due to its well strategy and efficient production focused on international quality, ANL was able to compete well in the challenging environment.
Hence, the gross profit margin showed an increase due to high gross profits in FY07 by cutting down on its COGS. The net margin nose-dived due to higher denominator effect ie robust sales compared to lower PAT. The 6% decline in PAT, despite 16% increase in EBIT was mainly due to higher financial costs, which soared by 66% in FY07 vis-à-vis FY06.
Both ROA and ROE showed a decline due to relatively higher increase in the company's assets and equity base with a 6-year CAGR of 54% and 100% respectively. However, these returns expected to improve in coming 2-3 years. The company is in the process to expand on its value added products to improve margins. All the liquidity ratios are showing that company is undergoing expansion, and it has maintained a good liquidity position over the years. Even in FY07 it has a current ratio above 1, and is able to pay its short term obligations very efficiently.
Inventory turnover (ITO) ratio depicts how quickly the company is able to sell off its inventory. The trend line indicates a relatively unstable ITO over the period with a very small ITO in 2004 mainly due to a very small inventory level in that year. ANL's ITO has declined in FY07, mainly on the back of robust sales showing efficiency on part of the company.
Days sales outstanding (DSO) shows how quickly the company is able to collect the dues from its debtors. It should be enough for the company to avoid risks of bad debts. DSO for ANL has been hovering between 80 to 90 days except in 2004 when it shot up to 159 due to high trade debts. Overall, the company may be pursuing an easy credit policy to attract more credit sales. The operating cycle followed the same trend as driven by ITO and DSO in respective years. It has further improved in FY07.
TATO of ANL has declined slightly over FY01-FY06, because the company is enhancing its assets base by investing long term for capacity expansion. The sales/equity, has also shown a negative trend, on the account of higher increase in equity base (mainly due to higher unappropriated profits) compared to increase in sales. However, both the ratios improved in FY07, due to impressive top line. As far as debt management is concerned, both D/A and D/E ratios show its decreasing reliance on debt financing compared to equity financing. The trend lines in particular show that initially both D/A and D/E ratios declined considerably over the years owing to company's shift towards equity in its capital mix. Same trend continued in FY07.
A sharp surge in the ratios in 2004 onwards was attributable to increased issuance of debts to finance the BMR. This is further confirmed by the long term debt to equity ratio which has increased considerably in 2005 due to increase in long term loans. It again rose slightly in FY07 due to TFC issuance to finance the acquisitions and BMR. The debt management ratios seem appropriate taking into account that the firm performed large expansion and BMR activities in past three years.
The TIE ratio has been rising till 2004 but tumbled later, due to very high finance costs coupled with comparatively lower increase in EBIT, thus having an adverse impact on ANL's interest covering ability. Increase in financial charges seem to grow as a result of Rs 16.6b bid for Pak-American Fertilizer (PAFL) that caused a hefty increase in borrowings in 2Q'06. The 6 months KIBOR rate also increased to 9.61% in Jun-06 from 8.64% in Jun-05. Looking at this, we can infer that ANL's interest covering ability has been affected adversely due to rising interest rates and the same deteriorating trend was witnessed in FY07, when the interest rates showed further hike.
Both the EPS and the year-end market prices have been increasing over the years, except in 2006 (due to increase in the number of outstanding shares) and 2007 (due to lower PAT). The (P/E) ratio showing how much the investors are willing to pay per rupee of the reported profits followed an erratic trend driven by the combined effect of EPS and market price of shares. The surge in FY07 multiple is mainly on account of lower EPS, despite lower market price. Overall, the share price followed a bullish trend in FY07 and managed to outperform the benchmark 100-index in July-07, after which it treaded on a bearish path.
ANL's book value per share shows a positive trend in FY07 on account of expanding equity base (due to an increase in retained earnings) compared to no changes in the number of outstanding shares. This reflects that now investors'/shareholders' increasing willingness to pay more for a share of the company. A decline in BV was seen in 2005 on account of higher increase in outstanding shares than the overall equity of the company. Also one can witness a regular dividend stream post-2004, major beneficiary of which will be Sheikh Family and JS group which together hold 66% shares of the company.
BUDGETARY IMPLICATIONS Recently, the government announced a special relief package for the export-oriented industry. As per the package, the textile industry in particular will not face any electricity disruptions during the day as against earlier outages of six hours a day during the peak hours. Rationalisation on the import duty on PSF from 6.5% to 4.5% and PTA would help the yarn manufacturers improve margins. While PTA is used to produce PSF, reduction in component's import duty would indirectly benefit the textile manufacturers like ANL.
Relaxation on other textile raw material imports would result in improved margins for the companies throughout the textile buckram chain, in particular ANL. However as none of these raw materials contribute mainly towards the manufacturing cost, hence the impact would be minimal. Increase in minimum salary from Rs 4,600 to Rs 6,000 would add to the costs of textile manufacturers, especially for the spinning and weaving sectors where majority of the labourers are unskilled and have their pay levels near the minimum floor. However this measure has been announced previously and the impact has been priced in at current levels.
The government has not provided any allocation for subsidy on textile research and development, compared to a Rs 19 billion subsidy allocation last year. However, following recently a strike by small textile manufacturers, the government has assured to consider restoration of the research and development (R&D) fund and reduction of gas prices for the textile sector. Overall, the budgetary measures introduced in the Budget FY09 will bode well for the textile manufacturers, as reduction in duties on raw material would likely have a favourable impact on margins. In Addition, the government also announced to facilitate in introduction and cultivation of Bt cotton. This action should help to bring the cotton cost down while improving yields at the same time.
With the relief measures, like subsidy on DAP being more than doubled from PKR 470 per 50-kg bag to PKR 1,000 per 50-kg bag coupled with abolishment of GST on all fertilizers, urea (with GST fixed at PKR 50 per 50-kg bag previously) and DAP would become cheaper by about 8% and 20% respectively. This reduction should provide significant relief to the farmer and rejuvenate demand provided that the international prices maintain a stable level. At present, the international DAP prices are moving upward steadily.
The current 31% increase in fuel/gas prices to result in Rs 25/bag rise in cost of urea, however, strong pricing power of the fertilizer sector companies is likely to allow them to pass on an increase in input cost to consumers. Furthermore, gas price increase is likely to be partially offset by abolishing sales tax on different fertilizers.
FUTURE OUTLOOK The global demand for textile products is growing annually at 2.5% and there is an immense potential particularly in the value-added segment, for the Pakistan exports. International fashion trends are moving more towards denim and the future years are anticipated to bring more balanced demand and supply conditions.
While the demand in international denim market continues to grow, the streaming additional production capacity in competing countries poses a threat. Moreover, Pakistani textiles industry has been facing tough competition from their regional competitors like China, India, Bangladesh and Sri Lanka, which got various subsidies and regulatory support from their respective governments. Hence the textile trading conditions might show marginal improvements. However, the management is striving for the value addition to product range by investing in human resources, achieving cost reduction and optimizing capacity utilization.
ANL has focused on garments production capacities keeping in view the very positive and encouraging global response for its garments. But at the same time rising interest rates, increased cotton and petroleum prices and double-digit inflation are likely to blunt the competitive edge. With expanded manufacturing facilities and new power plant, the company expects to further cut down on its fuel costs per ton in the coming years.
It is expected that as a result of acquisition of Target Company Montebello, the added capacity and new, diversified products, Azgard Nine will be able to increase its annual export by 20 percent per annum each year with higher value addition and profit margins and hence be able to offset various challenges faced by the textile industry in Pakistan. In terms of fertilizer business, the prevalent healthy market conditions are expected to yield good future results. Fertilizer market is highly productive because of the national economy's dependency on agriculture and because of the easier availability of credit for marginal farmers.
Post Pak American Fertilizers Limited (PAFL) acquisition, ANL has restructured the front end of the business by going into direct marketing and selling of newly launched TARA brand, which is now at price equity with market leaders. In future, ANL aims to capitalise on high margins and high growth segment of phosphatic fertilisers by establishing trading business (already achieved 7% market share in one year of operation).
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Azgard Nine Limited (ANL) - Financials
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Balance Sheet (PKR mn) FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Total non-current assets 988 1,958 2,351 3,042 5,681 14,041 14,275
Stores and spares 9 22 46 0 2,159 102 125
Stock in trade 246 722 1,266 73 2,034 2,023 2,246
Trade debts 337 533 537 1,395 1,014 1,135 1,657
Cash and bank balances 20 23 22 21 46 581 45
Total current assets 782 1,550 2,479 3,255 6,932 8,942 9,358
Total Assets 1,770 3,508 4,830 6,297 12,613 22,983 23,633
Total non-current liabilities 435 442 836 868 2,721 5,797 7,479
Total current liabilities 929 1,685 2,382 2,613 4,448 7,754 6,194
Total liabilities 1,364 2,127 3,218 3,481 7,169 13,552 13,673
Total Equity 152 1,020 1,279 4,610 3,093 9,174 9,720
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Income Statement (PKR mn) FY01 FY02 FY03 FY04 FY05 FY06 FY07
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Sales - net 1,257 1,931 2,428 3,156 4,422 4,890 6,628
Cost of goods sold 948 1,438 1,782 2,441 3,289 -3,703 -4,621
Gross profit 309 493 646 715 1,134 1,186 2,007
Profit from operations / EBIT 204 351 447 539 1,119 1,916 2,213
Finance cost 135 197 185 123 291 -656 -1,062
Profit before taxation 62 152 248 395 792 1,260 1,151
Taxation 5 -14 20 20 51 116 -72
Profit after taxation 57 165 228 375 741 1,145 1,079
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PROFITABILITY RATIOS FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Profit Margin 5% 9% 9% 12% 17% 23% 16%
Gross profit margin 25% 26% 27% 23% 26% 24% 30%
Return on Assets 3% 5% 5% 6% 6% 5% 5%
Return on Equity 14% 12% 14% 8% 22% 12% 11%
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LIQUIDITY RATIOS FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Quick Ratio 0.57 0.48 0.49 1.22 0.62 0.88 1.13
Current Ratio 0.84 0.92 1.04 1.25 1.56 1.15 1.51
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ASSET MANAGEMENT RATIOS FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Inventory Turnover(Days) 73 139 194 8 341 156 97
Day Sales Outstanding (Days) 97 99 80 159 83 84 68
Operating cycle (Days) 170 238 274 167 424 240 164
Total Asset Turnover 0.71 0.55 0.50 0.50 0.35 0.21 0.28
Sales/Equity 8.26 1.89 1.90 0.68 1.43 0.53 0.68
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DEBT MANAGEMENT RATIOS FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Debt to Asset 0.77 0.61 0.67 0.55 0.57 0.59 0.58
Debt to Equity Ratio 8.96 2.08 2.52 0.76 2.32 1.48 1.41
Long Term Debt to Equity(%) 2.86 0.43 0.65 0.19 0.88 0.63 0.77
Times Interest Earned 1.51 1.78 2.42 4.38 3.85 2.92 2.08
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MARKET RATIOS FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07
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Earning per share 2.08 2.64 2.63 4.31 7.42 4.97 3.26
Price/Earnings Ratio 3.65 3.11 4.33 5.63 5.13 7.97 10.56
Dividend per share 0.00 0.00 0.00 1.00 1.50 1.10 1.25
Book value per share 4.77 11.74 14.73 26.53 17.80 24.21 26.29
No of Shares issued (million) 31.91 86.87 86.87 173.73 173.73 378.88 378.88
Market prices(Average) 7.60 8.20 11.40 24.28 38.03 39.61 34.42
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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].
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