Allied Rental Modaraba proclaims itself as a multipurpose and perpetual modaraba, managed by Allied Engineering Management Company (Pvt) Ltd, a wholly-owned subsidiary of Allied Engineering and Services Ltd. Allied Rental Modaraba (ARM) commenced its business on January 10, 2007 with a capital 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 company offers its services in 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 of installation, operation and maintenance (except fuel) is solely borne by ARM. The equipment given on rent returns back to 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.
RECENT PERFORMANCE Q3FY09
As compared to last year's third quarter, Q3FY09 saw ARM performing commendably. The revenues grew by 54% to Rs 167.5 million. Gross profits increased to Rs 66.5 million at a rate of over 41%. The profit for the period managed to rise by 27.4% to reach Rs 42.4 million. The most significant development for the company in this quarter was proceeds of the rights issue.
These were used to procure rental equipment, which led to a greater rental fleet of ARM and a 68% increase in the tangible fixed assets of the company. This led to the 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 101%.
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. This trend still continues, giving ARM healthier profits.
As expected, the adverse situation prevalent in the economy has been reflected by a weaker profitability for ARM. Gross profit margin had been 43.2% in the third quarter of FY08, falling down to 39.7% in FY09's third quarter. The revenues of the company have been growing at a sturdy rate of almost 54%, as mentioned before.
However, the direct costs, or the operating costs have grown at a greater rate of 63% between March 08 and March 09. If we further analyze, the major components of operating costs are salaries and wages, depreciation expenses and repair and maintenance. The reason why operating costs have risen by such a large amount is due to a 64% rise in repair and 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 the third quarter of FY09. Depreciation expense formed 31% of all direct (operating) costs in Q3FY09, compared to 26% in the same period last year. All in all, this led to gross profits increasing by 41.2%, compared to the revenues' growth rate of 54%.
The effect on net profit margin was more profound, with the figures falling to 25.3% in Q3FY09 from 30.5% in last year's third quarter. The major reason for this trend was that the net profit only managed to grow by 27.4%, being adversely affected by an unprecedented rise in administrative and selling costs by 104%.
More specifically, the leading cost categories were salaries and wages, ommission, vehicle running costs and travelling and conveyance costs. The cost of travelling rose especially, ending up in a figure three times higher in Q3FY09 than the old figure of Q3FY08. Similarly, the rights issue offered by the company in December 2008 led to expenses which formed about 18.5% of all administrative and selling costs.
Thus the profitability of the company was affected in a negative way by increased cost of operation, selling and administration which in turn were caused by the high inflation in the country's economy. The liquidity position of ARM has been rather mixed. The current ratio shows a slight increase to 0.83 in Q3FY09 compared to 0.79 at the end of 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' 2.9% decrease was mostly on the back of a massive 92% decline in the bank balances of the company. These bank balances formed 54% of total current assets of ARM by FY08, while they now constitute only 4.5% in Q3FY09.
However, the company put in about half of their current assets in the form of short-term investments, something which neutralized the negative change in the bank balances. On the other hand, the ratio of income-to-expense show a decline to 0.34 in FY09's third quarter compared to 0.44 in last year's third quarter. The reasons for this trend were obviously because the growth in net profit was less than half of 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 Q3FY08 was 5.55 but it fell to 4.90 as at March 2009. This is evident as the EBIT has seen a net increase of 31%, while the finance cost that the company incurs grew at a higher rate of 49% within the same period.
This means that the company has increased its EBIT but at a higher cost of financing. The finance cost of ARM is almost exclusively composed of the financial charges on obligation against assets under Ijarah agreements. Interestingly, we increase in Ijarah financing charges although the equipment financed through Ijarah agreements have declined. Thus, we can attribute the higher Ijarah charges to the increased lending rate in the economy.
The market value of the company has obviously been affected by reduced growth of profits. The earnings per certificate in FY08 third quarter amounted to Rs 1.11. However, in the current financial year's third quarter, EPC went down substantially to Rs 0.71. At the same time we must remember that the decreased EPC is due to the increased number of modaraba certificates after the rights issue.
The number of certificates in the market increased by 50% while net profits increased by 27%. This meant an obvious decrease in the EPC. However, since the proceeds from the rights issue have been invested in the expansion of the company's rental fleet, the EPC is expected to grow in the long run.
PERFORMANCE TILL H1FY09
The balance sheet of Allied Rental Modaraba was almost Rs 976 million strong at the end of 2008. Before the commencement of FY09 second half, the company had crossed the one billion mark, with a balance sheet of Rs 1.173 billion. Also in H1FY09, 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 2008'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 would 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.
The net profit earned of Allied Rental Modaraba in FY08 amounted to around Rs 127.6 million, which is an astounding 120% higher than FY07's Rs 58 million. Only in the first six months of FY09, the company has 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.
Based on those figures, the profit is expected to swell in the third year of operations of the company in 2009. 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.
ARM has seen its profitability figures maintain a favourable level, despite a slight slump in FY08. The company reported a gross profit margin of 41.1% in 2008, which is down from 45.7% the year before which was also its first year operations. Net profit margin also followed a similar trend decreasing from figures of 33.2% in FY07 to 27.9% in the next year. In H1FY09, both the gross profit margin and the net profit margin improved to nearly 46% and 29% respectively.
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 458 million, which is an astounding 162% higher than FY07's Rs 174.5 million. This was mainly on the back of growth in operating lease rentals which made up 70% of the total revenues. Income from operations and maintenance saw a 2.5 times growth, driving the revenues further up.
In H1FY09, the company has managed to earn revenues of over Rs 308 million. On the other hand, the main reason for the decline in the margins of profit, both gross and net, are the greater growth rates seen in operating expenses and finance costs, both of which grew by over 200%.
The operating expenses for the year 2008 were twice that of 2007, due to more than two times growth in the expenses from salaries, wages and staff benefits, which form about 40% of the total operating expenses. 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 178% increase of the depreciation expense of the company.
The return on assets has improved in FY08 to 13.1% compared to 8.2% of FY07. The same trend was witnessed in return on equity which showed a larger increase, from 16% in 2007 to 28% in 2008. The basic reason for both these ratios of ROA and ROE is that the growth of net income far outpaced that of the total assets or the total equity. Net income increased by 120% while total assets grew at a rate of 38%.
The bulk of the total assets (about 80%) are in the form of tangible fixed assets that are leased out, and they grew by only 21%, neutralizing the phenomenal growth in other types of assets, such as the net investment in Ijarah finance which increased to thrice its 2007 figures. The increase in equity was lesser than that, being at 27%, resulting in a comparatively better ROE ratio.
The growth in equity was mainly due to increased unappropriated profit 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. The liquidity position of ARM is worrisome to say the least. 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 tripling expenses, it climbed back up to 41% by the end of the first half of FY09. It must also be noted that the management fee charged for managing the modaraba was very less in 2008 as it did not have any accruals. In H1FY09, this fee was waived by the company. According to the 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 a gloomy picture of ARM's liquidity situation. In 2007, the current ratio was 0.92, which declined to 0.79 in 2008. By H1FY09, this ratio reduced to an alarming level of 0.31.
Basically, the current liabilities have been increasing faster than the current assets, the reason being the mark-up free borrowing in 2008, from Allied Rental Services Ltd which is an associate company, and due to approaching maturities of liabilities on assets subject to Ijarah finance.
The slump in the current ratio in the first half of 2009 was mainly due to a decrease in current assets, led by a 71% decrease in bank balances, and a very large increase in current liabilities, fuelled by a four-time increase in payables that are to be given to associate companies for services rendered and purchase of parts and machinery. 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.
It is witnessed 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%, which in H1FY09 was 53% more than the figure for the same period in 2007, which is still very good.
This and the relative slower growth in Total Assets and Equity, at 38% and 27% have led to a better asset management for the company. The Total Asset Turnover has changed from 0.25 in 2007 to almost doubling it to 0.47 in 2008. Observing the Sales-to-Equity Ratio reveals the same trend, with the ratio soaring to 1.00 in FY08 from 0.49 in FY07.
The Debt Management Ratios clearly show that an increasing portion of the assets of the company is being financed by liabilities rather than the equity. The Debt-to-Assets ratio of ARM has increased to 0.53 in FY08, which is a minor change compared to 2007's 0.49. Total assets, as mentioned before, saw a reasonable growth but it was much less compared to the growth of the total liabilities. Long-term debt-to-equity was 0.46 in 2007, and inflated to 0.52, much like the debt-to-assets ratio.
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. The growth registered in this head was 21%, fuelled 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 H1FY09 which saw a nearly 50% growth. In contrast, liabilities of the company grew a higher rate of 49%.
About half of all liabilities are composed of those long-term ones that arise from assets subject to Ijarah finance. These grew at 45%, driving the pace of liabilities, clearly overtaking the growth shown by either assets or equity. That explains why the debt-to-equity ratio witnessed a marked change from 0.97 in FY07 to 1.14 in FY08.
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. This is 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 has adopted, the cost of borrowing hiked up the finance charges of ARM, increasing them by 212% in FY08.
Most of this increase is on account of obligations against assets under financial lease arrangements. In the first half of FY09, the TIE deteriorates further to 4.50 due to increase in the obligations mentioned above. The market value of ARM is quite favourable even in the market conditions prevalent nowadays. The earnings per certificate has more than doubled from Rs 1.93 in 2007 to Rs 4.25 in 2008.
In the first six months of 2009's financial year, the company saw its EPS touching the level of Rs 2.98. The certificates of the modaraba fund were valued at Rs 10.50 in July 2007, after the end of ARM's first financial year. The market price of the certificate shot up to Rs 36 just before the end of FY08 in June 2008. Price-to-earnings in 2007 was 5.44, which increased substantially to Rs 8.47 by the end of 2008.
The dividend paid to the certificate holders has been healthy till now, 10% and 20% of the par value of Rs 10 on each certificate. In both the past years, the number of issued certificates was the same at 30 million, yielding a book value per certificate of Rs. 11.93 in 2007 and Rs. 15.18 in 2008.
FUTURE OUTLOOKThe economy of Pakistan is still reeling from the shocks that came in the 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 our 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. He 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.
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