Case Study NIM Final

7/31/2019 Case Study NIM Final

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North India Metals1

Dr. Rahul Singh2 and Honey Joshi3

After having a tremendous growth in sales for the last four years, the North India Metals (NIM) waspondering about the stagnation in sales for the current year. This issue finally came to GoverningBoard for critically evaluating the possibilities to get the momentum going. Mr. James, ManagingDirector of North India Metals is in a state of confusion to justify the progress path of theorganisation. It is a small sector company with a turnover of around INR 1060 million. Thecompany is mainly into exports of casting components and offers a very justified portfolio of lowcost and good quality option for foreign companies. Thus the company is enjoying increasingdemands for the last four years due to increasing business internationally. There is a minor ratio ofdomestic business in the profit pie.

1.0 Background

There are more than 5,000 foundry (place of casting metals) units in India, having an installedcapacity of approximately 7.5 million tonnes per annum. The majority (nearly 95%) of the foundryunits in India fall under the category of Small and Medium Enterprises (SME). The foundryindustry is an important employment provider and provides direct employment to about half amillion people. Small sector industry being an important part of foundry industry makes itnecessary to have proper growth of these small scale units. Thus small scale units require thenecessary funds at regular intervals for proper growth; hence the valuation becomes an important

parameter for the assessment of these units. The reason of doing valuation of the small companies ata justified interval is that the funds can be made available as evaluated through the valuation of theunits and not just on the financial statements provided by the company.

North India Metals was established in 1983. NIM is a manufacturer of fully mechanized castcomponents made of copper, aluminium, zinc and ferrous alloys. Its head office is located in Delhi,India and it has manufacturing facilities in and around Delhi at 5 locations. The range of all themanufacturing units is within 50 kms, except one which is in another state (Rajasthan) close toDelhi. The Company Specialises in Sand Casting, High Pressure Die Casting, Investment Casting,Gravity Die Casting, Stamping, and Forging of Tubes. North India Metals exports its products toUSA, Canada, Germany, Australia and China.

1.1 Organisation Structure

NIM, a small scale industry, started as a small organisation headed by Managing Director, Mr. AJames. This was established under the view of increasing demand of the industry and also the pastexperience of the Managing Director in the sector. The organisation structure always has been veryflat and dependent on very few persons in the initial 15 years. With the increasing work andspecially year 2000 onwards organisation had a very strong progress chart which also increased themanpower size of the organisation. Since NIM had developed many manufacturing units, it was

1 This case has been developed on the research conducted on an organisation which is named North India Metal (the

real identity of the organisation is hidden). This has been done to avoid attention of critical analysis of the companysfinancials and its strategy. "(c) 2008, Rahul Singh and Honey Joshi, Birla Institute of Management Technology, allrights reserved.2 Assistant Professor, Birla Institute of Management Technology, Greater Noida, India.3 Masters programme student, Birla Institute of Management Technology, Greater Noida, India.

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important and critical to transfer some of the powers to the heads of respective units and make themaccountable. However MD Mr. James was very good person, he took some time to decide todevelop a strong system and performance appraisal on the issue.

Figure1: Organisation structure

Box: Brief History of NIM

1983- The North India Metals started its business by opening up a production unit in Libaspur, Delhi.The company started with Copper Foundry. This unit was a 100% export unit and manufacturingelectrical wiring accessories. The company took over all operations related to export of the assignmentsand did not involve any outside vendors for any functional service support like assembly, packaging anddispatching.

1989- This year company started with another plant at Sahibabad. This plant was an Aluminium DieCasting plant. The plant is producing electrical wiring accessories. 90% of its output is exported.

1991- In 1991, the company started with Zinc Die Casting at Sahibabad plant. The companys productline remains same and so the process. This was started to increase the product portfolio to meet the freshdemands in the international market.

1997 In order to meet the increasing demand and looking at the growth in the sector, the companystarted one more plant in Faridabad. This plant was converted to a EOU (export oriented unit) in 2005.Faridabad plant is a Sand Casting unit with semi automatic sand plant and induction furnace to meltcopper. It has a capacity of 100 ton of casting and machining of copper, aluminium, stainless steel andCI castings per month.

2001- As a result of high and intensive demand in the USA market, it started wholly owned subsidiary inUSA to warehouse and sell North India Metals products. In the same year, the company bought anotherunit in Sahibabad to strengthen the supply for meeting the demands.

2005 To increase the product portfolio further, NIM started investment casting facility at Faridabadplant. This was initiated to develop the capacity for casting of stainless steel.

2007 The company started the Neemrana unit in Rajasthan for steel tubes based components.Neemrana is approximately 125 kms from Delhi.

2.0 Industry Profile

The Indian Metal casting (Foundry Industry) is well established industry and has a long history of

Board of Directors

Director of Unit

Libaspur

Director of Unit

Sahibabad 1

Director of Unit

Sahibabad 2

Director of Unit

Faridabad

Director of Unit

Neemrana

Mr. A JamesManaging Director

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more than 150 yea India produces an estimated of 6 million Metric Tonnes of various grades ofcastings with International standards as per the recent survey of World Census of Castings by

Modern Castings, USA4.

The different types of castings which are produced are ferrous, non ferrous, aluminium alloy,graded cast iron, ductile iron, steel etc for application in automobiles, railways, pumps compressorsand valves, diesel engines, cement/electrical/textile machinery, aero and sanitary pipes & fittingsetc and castings for special applications. The business of the casting products is quite equally spreadexcept the Grey iron castings which commands the major share of the market and accounts forapprox. 70 % of total castings produced in India. The casting business is spread in cluster locationsaround India; however it has some dominant clusters in and around Batala, jalandar, Ludhiana,Belgaum, Chennai, Kolhapur, Rajkot, Coimbatore, Howrah, Agra, and Pune. Out of approximately4500 units in India, 80% can be classified as Small Scale units and 10% each as Medium & LargeScale units5. The quality issue is one of the sensitive characters of the industry for internationalmarket which leads to a small number of companies eligible for international market. As sucharound 500 units are having International Quality Accreditations in India. If categorised at small

and medium level companies, the capacity utilisation is not found very high and it ranges between50-65 % of the total capacity. The large foundries are demanding, equipped with moderntechnology and are globally competitive. Due to obvious vision and goals of the organisations, largeorganisations are working at nearly full capacity. Most of the foundries have been following similar

processing methods and install cupolas (furnace) which uses LAM Coke (burning material). Due toincreasing environmental compliances which are restricting organisations in many ways to useinappropriate processing methods, there is growing awareness about environment and manyfoundries are switching from the cupolas to induction furnaces which follow the coke less cupolasand reduce the environmental hazards.

Figure 2: Share of small & medium foundry industry in India

2.1 Employment

The manpower feed to the industry is quite extensive. It directly employs about half a millionpeople and indirectly about quarter a million people which very clearly indicates that it is labourintensive industry. The small units (employing manpower upto 30 persons) are mainly dependant onmanual labourer. However, the medium and large units are semi or fully mechanized and some ofthe large units operating in India are world class. India has major competitive advantage over thefoundry industries in the developed countries and one of the reasons of this leadership is low costmanpower. The labour cost of the industry account for 12-15% of the cost of the products.

2.2 Exports

Though most of the consumption is from the domestic market only, export has been increasing in

last few yea The exports are showing healthy trends which is increasing at 25-30% year on yearbasis as can be seen from the charts below. The current exports for financial year 2005-06 are

4http://www.indianfoundry.com/commercial/index.html, extracted on 23rd May 2008.5http://www.foundryinfo-india.org/About_Us/profile_of_indian.aspx, extracted on 28th June 2008.

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approximately USD 800 Million. Since the export demand is mainly from the high value addedproducts, the market size is special but not very large. As shown the export happens mainly fromsanitary and industrial castings which contribute to approximately 80 % of the export market value.

Figure 3: Trend of export of castings from India

2.3 Product Mix

The produce of industry are mainly in the product list of Sand Casting, High Pressure Die Casting,Investment Casting, Gravity Die Casting, Stamping, Forging of Tubes and few other bi-products.The Indian Foundry Industry is trying to focus on higher value added castings to beat thecompetition developing from country competitors. With the increasing global demand andinfrastructure development, grey iron is the major component of production followed by steel,ductile iron and non ferrous as shown below.

Figure 4: Product mix of foundry industry in India

2.4 Investments

India would need approximately USD 3 billion in investment to meet the demand of growingdomestic industry and strong export drive. Following the economic reforms the Government ofIndia has reduced tariffs on imported capital goods. As a result of this initiative, the annual averageamount of FDI is reported to have increased; however on the comparison of the flow of FDI India isstill one tenth of the annual FDI in China in this industry. The reform package offered many otherincentives to develop the market which included the privatization of industry enabling foreigncompanies to invest or enter into joint ventures with Indian Foundries. FDI projects are permitted

through an automatic approval process. Many global organisations belonging to countries such asUSA, France, Denmark, Germany, Netherlands, Ireland and few East Asian Countries haveincreased their overseas foundry operations in India. For example; VOLVO foundries in Chennai

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and Suzuki in Haryana have invested significant amount to enhance the operational facilities andcapacity. Sundaram Clayton has joined hands with Cummins, Hyundai Motors, and Delphi. FordIndia, Tata-Cummins, GM and Ford have contracts of foundry products for export with a value ofUSD 40 million.

2.5 Raw Material & Energy

Since the market has been growing in casting business, there has been a steep increase in cost ofraw materials and energy since year 2003. This has resulted in the closure of approximately 500units all over India which have been killed due to competition. Though India is exporting the pigiron as a finished product however it has to import scrap metals and coke etc. to produce thefinished products. Most of the time, cost recovery for material and energy is very difficult in a

product volatile costing and fixed product price market, as most contracts are long term contracts tofix up the finished good price without any clause for price adjustment, however costs of rawmaterial keeps changing its cost behaviour. On the raw material side, India has to import coke andscrap and moulding sand is locally available. The energy cost typically varies between 12-15% on

the final product cost.

2.6 Technology

The changing policies of Government of India (GOI) have encouraged technology transfer throughjoint ventures with foreign companies. They have also collaborated with UNIDO for producing thevalue added products by many foundry clusters. This has been mainly taken into due to technologysupport provided by UNIDO. Indian foundry industry has an edge over China for producingcomplex mechanised and precision castings as per international quality standards. The clusters inBelgaum, Coimbatore and Howrah are undergoing modernization under the industrial infrastructureupgradation scheme of the governments. More of such clusters are likely to follow in future to meetthe domestic and international demands.

2.7 Government Policy

After liberalisation, privatisation and globalisation starting in India in 1911, many policies haveundergone review and change. Export and import issues being one of the major concerns, havereceived very encouraging response. Along with many changes taking place with the passage oftime, the improvements after year 2000 made significant difference in the performance of theindustry. Some of the developments are like treating Sales from DTA to SEZ as export andtherefore eligible for DEPB and refund / exemption of CST and Service Tax. Foreign bound

passengers allowed taking goods from SEZ and EOU units6. Domestic Sales by SEZ exempted fromSpecial Additional Duty. Requirement of realizing export proceeds within 1 year from the date ofexport removed for SEZ units and requirement of maintaining value addition as per export

performance as per value addition for EOUs substituted by net foreign exchange earning. Inaddition to his, there are many other benefits by running operations through EOU7.

The incentives and facilities offered to the units in SEZs for attracting investments including foreigninvestment include:

1. Duty free import/domestic procurement of goods for development, operation andmaintenance of SEZ units

2. 100% Income Tax exemption on export income for SEZ units under Section 10AA of theIncome Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the ploughed

back export profit for next 5 yea

6

http://www.ibef.org/artdisplay.aspx?cat_id=60&art_id=16798, policy paper extracted on 22nd

May 2008.

7http://cii.in/menu_content.php?menu_id=624, andhttp://goidirectory.nic.in/ , extracted on 14th May 2008.

http://www.ibef.org/artdisplay.aspx?cat_id=60&art_id=16798

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3. Exemption from minimum alternate tax under section 115JB of the Income Tax Act.4. External commercial borrowing by SEZ units up to US $ 500 million in a year without any

maturity restriction through recognized banking channels.5. Exemption from Central Sales Tax.6. Exemption from Service Tax.7. Single window clearance for Central and State level approvals.8. Exemption from State sales tax and other levies as extended by the respective State

Governments.

2.8 Exchange Rate

Indian rupee has been very volatile in its performance in last few years. The low and high of themarket has been disturbing sign for various stakeholders of the market. The weakening of the valueof rupees against US dollar has uplifted the exporters and created a favourable market.

Figure 4: Indian rupees against US Dollar from 2001 to 2008

Source :http://www.fxstreet.com/rates-charts/advanced-charts/

3.0 NIM Transition Phase

The company was growing at the industry average growth rate which has been the normal progressfor long till year 2004. In the changed scenario, the sales of the company suddenly started pickingup year on year significantly till early 2007. The company also, on the other hand, planned to buildits strength by constantly increasing the production capacity in order to sustain the demand

pressure. As singular economics works, with the increase in production of finished goods othervariables also increase which were alarming indicators for the organisation such as inventorystorage, raw material cost etc. NIM is exporting around 90-95 % of the production since inception.

That means it is heavily dependent on the global market demands and fluctuations in the demand.Not only the demand has been a critical issue but also the exchange rate between INR and USD hascreated its pressure on the financials of the organisation. The red signal comes this point in time inyear 2007, which stagnated the demand side from the global market after few years of steep rise.

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stockholders. A simpler way of getting to free cash flow to the firm is to estimate the cash flowsprior to any of these claims. Thus, we could begin with the earnings before interest and taxes, netout taxes and reinvestment needs and arrive at an estimate of the free cash flow to the firm.

FCFF = EBIT (1 - tax rate) + Depreciation - Capital Expenditure change inWorking Capital

The model is implemented for valuation in year 2007 only. The valuation of the company found byFCFF model is close to INR 3.36 billion. The company is having good sales growth of around 21%which brings the company above than around 25 companies listed in the stock exchange. This givesa positive sign for the listing the company, however decision of course belongs to the Board.

Though the company is not considering the interest paid on the funds made available by the internalaccruals but in the FCFF valuation it has to be taken into consideration. The current assets of thecompany are much more than liability, leading to increase in working capital. As the company ismainly into exports and depends upon the other countries for sales the risk premium attached to it

gets increased depending on the market volatility. As a result, with lower debt equity ratio, thecompany valuation gets affected as getting the funds is comparatively cheaper than the cost ofequity.

4.2 Model B: EVA Valuation

The purpose of EVA-Valuation9 is to measure the total value added of a companys operations, i.e.the net cash generated in excess of claimholders return requirements. The computation of EVA isclosely related to DCF. Hence, it starts with EBIT and ends with the fair value of the share. Theshare price potential (which the investors are interested in) is computed by comparing the fair valuewith the current market price of the share. The basic formulation of EVA valuation is as follows:

EVA is computed so that the "fair rate of return to invested capital", i.e. WACC times the investedcapital, is subtracted from the Net Operating Profit Less Added Tax (NOPLAT).

The EVA valuation, on the model used with adjusted values, has indicated the valuation of the firmat INR 5.11 billion. The factor of illiquidity discount is also taken into consideration, as the value socreated can not be channelized at the time of selling the business or coming up with an IPO. TheEVA valuation is done keeping all the data same as projected profit figures and the WACCcalculated for the FCFF model. The model also takes into the consideration of stable growth, ROCand capital invested in the business.

The significant difference in the valuation between FCFF and EVA is a point of further analysis.This may have many reasons including the assumptions and treatments of the variables by thefinance manager.

4.3 Model C: Relative Valuation

Relative valuation10 is a generic term that refers to the notion of comparing the price of an asset tothe market value of similar assets. In relative valuation, the value of an asset is derived from the

pricing of 'comparable' assets, standardized using a common variable such as earnings, cash flows,

9 http://pages.stern.nyu.edu/~adamodar/, corporate finance by Aswath Damodaron, Kaplan, S.N. and R.S. Ruback,

1995, The Valuation of Cash Flow Forecasts: An Empirical Analysis, Journal of Finance, v50, 1059-1093

10 http://pages.stern.nyu.edu/~adamodar/, corporate finance by Aswath Damodaron, Kaplan, S.N. and R.S. Ruback,

1995, The Valuation of Cash Flow Forecasts: An Empirical Analysis, Journal of Finance, v50, 1059-1093

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book value or revenues. Examples include -1. Price/Earnings (P/E) ratios and variants (EBIT multiples, EBITDA multiples, Cash Flow

multiples)2. Price/Book (P/BV) ratios and variants (Tobin's Q)3. Price/Sales ratios

While comparing the company financials with the financials of the industry some basic similarityhas to be taken into consideration. Through relative valuation, the market position of the companyis determined to check the various options like selling a part, or inviting a private equity. Thefollowing assumptions have been honoured to establish the valuation;

1. The sector itself is, on average, fairly priced2. The earnings of the firms in the group are being measured consistently3. The firms in the group are all of equivalent risk4. The firms in the group are all at the same stage in the growth cycle5. The firms in the group are of equivalent risk and have similar cash flow patterns.

As the main objective of the relative valuation is to compare the assets and other financials ofcompanies of similar nature and risk, the position of NIM compared with the listed companies ofsimilar risk and approximately similar turnover, has been found rather satisfactory. NIM is provingto be a low cost manufacturing company and as such it has comparatively higher margins. Lookingat the industry average margins of comparable group which stands at 6.35%, the NIM is earning at avery healthy rate of 21.33%. Also the return on capital invested is quite above the industry average.The company is close to industry average in payout ratio. But having generated a net profit marginof 21.33% the company is providing good amount of funds for distribution. Following is the

presentation of some fo the relative scales.

5.0 Closing Statement

After getting the three models by the finance managers, Mr. James is not very clear with thedecision. The financial models of valuation indicate a high variability in them selves and representvery different picture all together.

Board has several options and little confusion such as existing capacity utilisation vs. expansion,raising debt vs. getting IPO, creating a joint venture, domestic market vs. export market, selling oforganisation.

He wants to have clearer picture thus he invites a group of consultants and provide them with the

details of the situations which are company profile, market scenario, the financial valuations,balance sheet etc. and ask them to suggest the most close to perfect solution.

Issues to Ponder on:

1. Given the understanding and data, which valuation method is the best suitable for theorganisation and why?

2. As expressed in the concluding statement by Board, what should be best two decisions byBoard in priority. Produce support statements to your view.

3. What should be the strategy to increase the long term profitability given the industry

scenario?

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Appendix 1: Variables of choosing the right valuation model

Sign Earnings

Normalcy Growth Source of g

Dividends

vs. FCFE Leverage

Other

Factors Valuation Model

+'ve Normal Stable NA =FCFE Stable NA Gordon Growth

+'ve Normal Stable NA FCFE Stable NA FCFE Stable

+'ve Normal Stable NA NA Unstable NA FCFF Stable

+'ve Normal Moderate General =FCFE Stable NA H Model

+'ve Normal Moderate Specific =FCFE Stable NA 2 stage DDM

+'ve Normal Moderate Specific FCFE Stable NA 2 stage FCFE

+'ve Normal Moderate Either NA Unstable NA 2 stage FCFF

+'ve Normal High Either =FCFE Stable NA 3 stage DDM

+'ve Normal High Either FCFE Stable NA 3 stage FCFE

+'ve Normal High Either NA Unstable NA 3 stage FCFF

+'ve Abnormal NA NA NA Stable NA Normalized EPS

+'ve Abnomal NA NA NA Unstable NA Normalized FCFF

-'ve Cyclical NA NA NA Stable NA Normalized EPS

-'ve Cyclical NA NA NA Unstable NA Normalized FCFF

-'ve Troubled NA NA NA Either Turn around FCFF Model

-'ve Troubled NA NA NA Either Bankruptcy Option Model

-'ve Start-up NA NA NA Either Many lines FCFF Model

-ve Start-up NA NA NA Either Single line Option Model

Appendix 2: Profit and loss account (amount in INR millions)

Particulars Schedul 2004 2005 2006 2007

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e

Income

SalesH

383.28465.8

8 566.94 1061.76

Other Income I 25.41 35.01 16.021 16.81

Incr./(Decr.) in WIP and Finished GoodsJ

(13.19) 22.25 10.94 49.43

395.5523.1

4

593.90

1 1128

Expenditure

Consumption of Raw Materials K 153.14 250.05 293.33 570.026

Manufacturing Expenses L 74.83 89.51 91.35 130.057

Administrative Expenses M 50.2 52.22 53.69 76.95

Selling and Distribution Expenses N 27.65 33.25 40.98 60.76

Financial Expenses O 1.18 3.47 4.74 14.072

Depreciation D 21.05 25.01 26.077 27.75

328.05453.5

1

510.16

7 879.615

Profit Before Taxation 67.465 69.64 83.734 248.384

Less: Provision For Taxation 17.5 15.5 10 21

Less: Provision Of Debt 0.75 0.9

Profit After Tax 49.965 54.14 72.984 226.484

Balance B/F from Last Year 5.79 33.87 26.326 18.628

Investments Written Back 0.034

Profit Available For Appropriation 55 88.011 99.31 245.112

Appendix 3: Balance sheet of NIM

PARTICULARS 2004 2005 2006 2007

Share holder's fund

Capital 21,120,000 21,120,000 21,120,000 21,120,000

Reserves and surplus 443,527,863 485,978,125 528,280,060 704,954,399

Loan funds

Secured loans 25,343,763 80,523,184 89,022,907 239,574,544

Unsecured loans 0 0 10,000,000 7,000,000

Deferred tax liability 12,483,779 12,197,531 12,767,978 13,368,299

Total 502,475,406 599,818,840 661,190,945 986,017,243

Application of funds

Fixed assets

Gross block 288,736,036 333,212,068 348,753,688 415,784,992

Less :- depreciation 147,843,380 158,245,838 182,552,494 209,606,454

Net block 140,892,655 174,966,229 166,201,193 206,178,537

Capital work in progress 30,230,789 18,858,150 37,400,742 55,584,199

Investments 6,716,750 216,750 216,750 216,750

Current assets, loans and advances

Inventories 126,058,260 16,958,557 24,329,885 346,756,757

Sundry debtors 119,429,897 156,152,068 162,367,548 313,465,222

Cash and bank balances 66,398,791 44,428,443 44,220,376 42,668,733

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Loans and advances 70,447,241 113,119,271 105,364,059 168,428,119

Total 382,334,191 483,298,341 555,250,840 871,318,833

Less:- current liabilities and provisions

Liabilities 12,256,164 26,705,681 19,476,533 25,619,432

Provisions 45,442,816 50,814,949 78,402,047 121,661,646

Total 57,698,980 77,520,630 97,878,580 147,281,078

Net current assets 324,635,211 405,777,711 457,372,259 724,037,755

Total 599,818,840 502,475,406 661,190,945 986,017,243

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Case Study NIM Final