Allied Rental Modaraba proclaims itself as a multi-purpose and perpetual Modaraba managed by Allied Engineering Management Company (Pvt) Ltd, a wholly owned subsidiary of Allied Engineering & Services Ltd. Allied Rental Modaraba (ARM) commenced its business operations on January 10th, 2007 with equity of Rs 300 million.
ARM is mainly involved in the Rental business. It manages the rental fleet of equipments comprising Power Generation Equipment, Material Handling Equipments and Construction related machinery. The cities in which the company offers its services are Karachi, Lahore, Islamabad, Multan, Faisalabad, Peshawar and Quetta.
The business model of Allied Rental Modaraba is of Ijarah in Islamic terminology, where the equipment is given on rent for any period ranging from days, weeks or months and all the costs related to installation, operation and maintenance (except fuel) are solely borne by ARM. The equipment given on rent is taken back by ARM for re-servicing and in order to get it ready for the next deployment. The aim of the company is to cater to its client's short-to-medium term needs for the use of the equipment without any capital commitments.
The rental fleet of Allied Rental Modaraba includes Diesel Generators, Gas Generators, Fork Lifters, Motor Graders, Compactors and Wheel Loaders. It was included in the recent re-composition of the KSE-100 as an incoming company along with 5 other companies.
Company Performance FY09:
As compared to last year's third quarter, Q3FY09 saw ARM performing commendably. The gross revenue grew by 38% to Rs 633 million. The profit ratio over sales remained constant at 28% despite difficult market conditions and recessionary pressures. This is despite 32% increase in financial charges and Rs 4.4 million spent for various expenses for the rights issue. The Gross Profits increased to approximately Rs 270 million at a rate of over 40.4%. The Profit for the Period managed to rise by 38.1% to reach Rs 176 million.
The most significant development for the company in this year was enhancement of the Capital Fund by the issue of 100% Rights Certificates at a premium of Rs 3/-certificate. The issues were fully subscribed and the proceeds amounting to Rs 390 million were received in the month of February 2009. The Rights Certificates were used to procure rental equipment which led to a greater rental fleet of ARM and a 64.5% increase in the Tangible Fixed Assets of the company. This led to an increase in Non-Current Assets of ARM by a rate of 52%. This is interesting since negative growth was seen in Current Assets, Current Liabilities and Non-Current Liabilities. However, the growth in Equity was at a phenomenal 111%. Thus, we see that ARM's sole focus was the expansion of its rental fleet through equity financing to poise for growth in the future, something which the newly formed company had to do sooner or later.
Since Q1FY08, the management company has waved the Management Fee from the Modaraba. As a result profitability has not been affected significantly. The Gross Profit Margin had been 41.6% in FY08 to 41.5% in FY09. The Revenues of the company grew by a sturdy rate of almost 40.7%. However, the Direct Costs, or the operating costs have grown at a greater rate of 41% between FY08 and FY09. If we further analyze, the major components of operating costs are Salaries & Wages, Depreciation Expense and Repair & Maintenance. The reason why operating costs have risen by such a large amount is due to a 64.6% rise in Repair & Maintenance Costs and a near 100% growth in the Depreciation Expense. Understandably, the phenomenal rise in depreciation is a result of major equipment acquisition that the company has gone through in FY09. All in all, this led to Gross Profits increasing by 40.7%, compared to the Revenues' growth rate of 40.4%.
The effect on Net Profit Margin was marginal, with the figures falling to 27.1% in FY09 from 27.6% in FY08. The company was thus able to recover from FY08's poor performance in terms of profitability due to high inflation in the country last year primarily due to major investment in the business ie asset accumulation.
The Liquidity position of ARM has been rather mixed. The Current Ratio shows an increase to 0.90 in FY09 compared to 0.79 in FY08. Although both Current Assets and Current Liabilities showed a decline from their FY08 figures, the decrease in current liabilities was more profound than the current assets. The Current Assets' 18% decrease was mostly on the back of a massive 71% decline in the Bank Balances of the company. These Bank Balances formed 54% of total current assets of ARM in FY08, while they now constitute only 19% in FY09.
On the other hand, the ratio of Income-to-Expense shows a very marginal decline to 0.37 in FY09 compared to 0.38 in FY08. The reasons for this trend were obviously because the growth in Net Profit was less than the growth in Expenses of the company. The company attributes the trend in Income-to-Expense ratio to rising costs of parts and services, increased salaries and wages, and the devaluation of the rupee.
The Times Interest Earned ratio for FY08 was 4.88 but it rose to 5.05 during FY09. This is evident as the EBIT has seen a net increase of 37%, while the Finance Cost that the company incurs grew at a lower rate of 32% within the same period. This means that the company has increased its EBIT and that too at a lower cost of financing. The Finance Cost of ARM is almost exclusively composed of the financial charges on obligation against assets under Ijarah lease agreements. Interestingly, we see a decrease in Ijarah financing charges in addition to the equipment financed through Ijarah agreements that has also increased. Thus, we can attribute the lower Ijarah charges to a decreased lending rate in the economy.
The Market Value of the company has partly improved due to a consistent growth of profits. The Earnings per Certificate in FY08 amounted to Rs 3.37. However, in FY09, rose to Rs 3.60. The Cash Dividend per certificate reduced by 25% from Rs 2 in FY08 to Rs 1.5 in FY09. This is primarily due to the fact that ARM just started operations in 2007 and can not guarantee very high dividends as of now in order to keep shareholders' future expectations rather reasonable.
PERFORMANCE TILL FY09:
The balance sheet of Allied Rental Modaraba was almost Rs 1.3 billion strong at the end of 2009. Also in FY09, the company was granted permission to have total authorized certificates of 75 million of Rs 10 each, a cumulative of Rs 750 million. This is a 50% increase from FY08's Rs 500 million of authorized certificates. The outstanding certificates are 30 million at the rate of Rs 10 each. It was also decided in October 2008 that a 100% rights issue will be done, at a premium of Rs 3 per certificate. By January 2009, the company received Rs 390 million in Modaraba funds by issuance of its certificates. These proceeds will be used to finance the purchase of new equipment and for expanding the rental fleet of the company.
PROFITABILITY:
The Net Profit Earned of Allied Rental Modaraba in FY09 amounted to around Rs 176 million, which is an astounding 38.1% higher than FY08's Rs 127.6 million. Only in the first six months of FY09, the company had managed to earn a net profit of Rs 89.3 million, in spite of the multitude of problems that the industrial and financial sectors of the country were facing. According to law, if 90% or more of the Modaraba's net profit (after deducting reserve requirements) are distributed to the certificate holders, then no taxes are charged on the profits earned.
Allied Rental Modaraba has seen its profitability figures maintain a favorable level, despite a slight slump in FY08. The company reported a Gross Profit Margin of 41.5% in 2009, which is down from 41.6% the year before which was its 2nd year in operation. The Net Profit Margin also followed a similar trend decreasing from figures of 27.6% in FY08 to 27.1% in the next year.
Being a company that has spent a short time since its inception, the growth rates it has experienced are understandably enormous. The Revenues amounted to around Rs 650 million, which is a massive 41% higher than FY08's Rs 462 million. This was mainly on the back of growth in Operating Lease Rentals which made up 70% of the total revenues in FY08. On the other hand, the reason for slight decline in the margins of profit, both gross and net, are the greater growth rates seen in Operating Expenses and Finance Costs. The Operating Expenses for the year 2009 were 41% more than that of 2008, due to 30% growth in the expenses from Salaries, Wages and Staff benefits, which formed about 38% of the total Operating Expenses in FY08. These expenses were also driven up by Repair and Maintenance Expenses and the Depreciation Expense. The procurement of equipments and parts, decreasing the useful lives of generators and office equipment (ie computers) are some factors that have led to 21.2% increase of the Depreciation Expense of the company.
The Return on Assets has improved in FY09 to 13.8% compared to 13.1% of FY08. The opposite trend was witnessed in Return on Equity which showed decrease, from 28% in 2008 to 18.3% in 2009. The reason for a rise in ROA is that the growth in Net Income outpaced the growth in Total Assets. The Net Income increased by 38.1% while Total Assets grew at a rate of 30.4%. The bulk of the Total assets (about 60%) are in the form of Tangible Fixed Assets that are leased out, and they grew by a whooping 64.5%. However, ROE fell massively because growth in Equity outstripped Net Income growth. The increase in Equity was 111% compared to previous year.
The growth in Equity was mainly due to the issuance of new shares in to the market, creation of premium on Rights Certificates. and the building up of the Statutory Reserve of ARM, in accordance with Modaraba-related regulations. According to these laws, 20% to 50% of the after tax profits for the year must be transferred to the statutory reserve of the Modaraba. Since its inception, ARM has chosen to transfer 45% in 2007 and 50% in 2008 of its net income to the reserve, citing that the company did it to meet the increasing capital expenditure requirements and to stay ahead of the competition.
LIQUIDITY:
The Liquidity position of ARM was worrisome to say the least at the end of FY08 but has improved significantly. But this is not the conclusion that can be drawn by looking at the Income-to-Expense Ratio. Although that ratio has declined to 38% in FY08 from 45% in FY07, considering the company's expense growth exceeded income growth by 3%, it has remained around about 37% during FY09. It must also be noted that the management fee charged for managing the modaraba was waived by the company in 2008 and in FY09 as well. According to law, the company can charge up to 10% of net profit as modaraba management fee. The fee waiver shows that it is an effort by the management to improve ARM's performance, at least on paper.
However, the Current Ratio paints to the fluctuating nature of ARM's liquidity situation. In 2007, the Current ratio was 0.92, which declined to 0.79 in 2008 and jumper back up to 0.90 in 2009. Basically, the Current Liabilities, in 2009, decreased at a faster rate of 28% compared to Current Assets that decreased at a slower rate of 18%. The slump in the Current Ratio in the first half of 2009 was mainly due to the decrease in Current Assets, led by a 71% decrease in Bank Balances, and a very large increase in Current Liabilities, fueled by a four-time increase in Payables that are to be given to associate companies for services rendered and purchase of parts and machinery. But by year end this loan from the associate company was fully paid up thus significantly reducing Current Liabilities. The only respite for ARM is that its creditors are also its associate companies, meaning there could be some breathing space granted to ARM so that it can improve its liquidity position.
ASSET MANAGEMENT:
We saw that despite the turmoil in the country's economy, Allied Rental Modaraba has managed to churn out impressive growth in its Sales or Revenue figures. In 2008, the increase registered in Sales was 162% followed by a 41% increase in 2009, which is still very good for a relatively new company. There has been a relatively slower growth in Total Assets of about 30%. Thus the Total Asset Turnover has changed from 0.47 in 2008 to 0.51 in 2009. On the other hand, due to the issuance of new shares, the Equity has taken a boost due to which there has been a fall in the Sales/Equity ratio from 1.01 to 0.68. This temporary reduction however should be taken positively as future sales will increase in the future as more investment has taken place in the business. That would possible restore the Sales/Equity ratio to its initial values.
DEBT MANAGEMENT:
The Debt Management ratios of ARM clearly show that an increasing portion of the assets of the company were being financed by liabilities rather than equity up till 2008 but things took a change in 2009 as share of equity rose. The Debt-to-Assets ratio of ARM has decreased to 0.24 in FY09, which is a major change compared to FY08's 0.53. The Total Assets, as mentioned before, saw a reasonable growth of 30% but Total Liabilities on the other hand reduced by 40% primarily due to the reduction of the Long-term Liabilities. The dual impact resulted in such a high reduction in the Debt-to-Asset ratio. Long-term Debt-to-Equity was 0.46 in 2007, inflated to 0.52 but then dropped to 0.11 due to a dual effect once again: significant rise in Equity and a significant fall in Long-term Liabilities especially due to the reduction in Liabilities Against Assets Subject to Ijarah Finance.
The major driver of the Total Assets is the Fixed Assets head, which is composed of the tangible and leasable assets that ARM possesses, forming 60% of all assets of the company in FY08 and 77% by end of FY09. The growth registered in this head was 64.5%, fueled by the procurement of Operating Assets, especially generators, forklifts and other machines related to earth-moving. The increase in this procurement was much more evident in FY09 which saw a nearly 50% growth. In contrast, Liabilities of the company shrunk by 40%. About half of all liabilities are composed of those long-term ones that arise from assets subject to Ijarah finance. These reduced by 56%, driving the direction of liabilities. That explains why the Debt-to-Equity ratio witnessed a marked change from 1.14 in FY08 to 0.32 in FY09.
The Times Interest Earned Ratio was also showing a downfall, from 6.50 in 2007, to a worse 4.88 by the end of 2008. However, it then rose a bit to 5.05 in FY09. The initial fall in TIE was mainly due to the rise in cost of capital that was prevalent in the financial markets in the recent turbulent times. Combined with the policy of aggressive procurement and expansion in rental equipment that ARM adopted, the cost of borrowing hiked up the Finance Charges of ARM, increasing them by 212% in FY08. Most of this increase was on account of obligations against assets under financial lease arrangements. In the 1st half of FY09, the TIE deteriorated further to 4.50 due to increase in the obligations mentioned above. But in the 2nd, TIE rose substantially to 5.05 due to increase in EBIT that exceeded the increase in finance charges. This happened probably due to a decrease in lending rates.
MARKET VALUE:
The Market Value of ARM is quite favorable even in the market conditions prevalent nowadays. The Earnings per Certificate has more than rose from Rs 1.93 in 2007 to Rs 3.37 in 2008 to Rs 3.60 in 2009. The market price of the certificate shot up to Rs 36 just before the end of FY08 in June 2008. The Price-to-Earnings in 2008 was 5.04 which increased substantially to Rs 3.05 by the end of 2009. The dividend paid to the certificate holders during the 3 years has been healthy till now; 10%, 20% and 15% of the par value of Rs 10 on each certificate in FY07, FY08 and FY09 respectively. In the first 2 years, the number of issued certificates was the same at 30 million, yielding a Book Value per Certificate if Rs 11.93 in 2007 and Rs 15.18 in 2008. However, in the 3rd year of operation a further 30 million shares were issued rendering a Book Value of Rs 16.03.
Future Prospects:
The demand for the rental equipment in the power generation segment is on the rise and ARM is maintaining its leadership position in this market segment with the largest and diversified variety of power generation equipments. ARM offers both diesel and gas power generation equipment ranging from 100kva to 2000kva. However, due to the roll back of the development projects, the demand for earth moving equipments is stagnant.
The economy of Pakistan is still reeling from the shocks that came last year and the situation will not be very bright in the near future. The industrial growth is set to decline even further due to various reasons such as frequent power outages, sky-rocketing inflation rates, high cost of borrowing and decreased local and international demand for ARM's products. This may seem like a very negative picture, but it can also mean that more industrial units would look to cut down their capital expenditures in the short or medium run and instead opt for leased equipment and machinery, a good sign for the company.
However, the company has shown strong growth ever since it started operating. In the first year of operations, it was among the top 10 modarabas in terms of equity and book size. Even more surprisingly, in terms of profits, it was among the top 5 of all modarabas. This has set the tone for ARM, and the company is geared towards expansion of its rental fleet. Due to this, it has managed to conduct a rights issue, which will be bringing in an additional capital of Rs 390 million into the fund in the future. Considering the fact that ARM was feeling the brunt of high finance charges, financing by equity will be a welcome respite that would curtail expenses.
Furthermore, considering that ARM will see more liabilities maturing than assets, continuously from now till the next 2 to 3 years, the company needs to finance these maturing commitments from somewhere. The interest rates and hence the cost of borrowing are not expected to show a radical decrease during this time. In that context, financing from equity will be essential, and for that the confidence of certificate holders in the company will be essential. Thus, the company should continue to distribute its profits among the certificate holders, as it has done in the last two years.
Most of ARM's clients belong to a few sectors of the economy. Recently, it has concentrated on the Cement and Construction sectors. Both of these sectors are interdependent and we do see a decline in the demand for both sectors' products and services. Furthermore, the government has cut spending on Public Sector Development Projects in the current budget, a demand generator for construction and cement, and the same is expected in the next financial year. Since nearly 40% and 25% of ARM's credit portfolio is made up of Cement and Construction sectors respectively, this would be a matter of concern for the company.
It may be difficult for ARM to look towards other sectors which will be witnessing growth and are also being given incentives by the government in the short to medium term, for example Energy, Oil and Gas which current make less than 3% of the credit portfolio. The reason for this is that a portion of the products offered by ARM are more related to activities of construction and cement sectors than others, eg earth-moving equipment. However, Exploration and Production can be catered by ARM, especially if it involves mining activities, such as coal mining. ARM is focused on expanding its rental fleet which could be beneficial in terms of diversifying its services to other sectors.
The acute shortage of power faced by country's industrial units has been an opportunity for ARM as it offers power generators on lease. Reduced fuel prices internationally have been an added factor that increased the generators' demand. In the short-term, the country will probably continue to face such shortages of power, but the government has been working to improve the situation in the longer-run. The prices of oil may also go up, close to its previous inflated levels. Thus, ARM must look towards other greener pastures at that time, when the demand for power generators decreases.
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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