appraisal - mbfi

8/8/2019 Appraisal - MBFI

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Appraisal and

credit sanction



Basic tenets

Comprehensive credit appraisal

Capability

Intent

Perfect documentation

Close and regular follow up



W

hat is the driving force ? Need to report higher earnings ?

Need to borrow more ?

Need to pay lower taxes ?

Depends on

Constitution of borrower Listed / unlisted

Future borrowing program



Appraisal Look for management decisions

Deferring expenses - profits overstated

Operating expense capitalized ? ² profitoverstated Advt expense ( high ??)

Installation expense (not conservative)

Forex losses incurred on loans raised for capex

Capital expense considered as revenue ² profitunderstated Textile companies



Possible pitfalls

Higher projected bank finance by

Overestimating sales

Overestimating stock and receivables

Underestimating current liabilities

Higher working capital gap and hence

overestimating of NWC



General caveats What may be perfectly right as per Accounting

standards ² may be perfectly unacceptable to abanker.

Bias towards conservatism

Take the most conservative position, see if it is stillacceptable, plan possible risk mitigants and

proceed. Manage risk ² don't avoid «& to manage you

should know what is the risk in the first place !



Checks Sales growth ?

Due to increase in units sold ?

Due to increase in price per unit ?

Due to inflation ?

Check installed capacity and capacityutilization

Normal growth ? Abnormal growth ? How diversified is the customer base ?



Checks Sales growth ? Has net sales grown due to impact of

reduction in excise duty ?

Has the receivable period increased ? Check both b/s receivable + bills discounted

Sales to group companies ?

Competed contract method ² certified ?

Check segment wise sales and segmentwise results



Checks Operating income Vs non operating income

How much as % of PAT ?

Profit on sale of RM , store etc

Fee income from group companies ? Subsidies ?

Freight and forwarding income

Income from sale of DEPB license ?

Profit on sales of investments ? Fixed assets ? \ Sale of assets at inflated price to group companies

«.and lease back ?? ² check fixed asset schedule

Onetime write back of provisions

Compensation received for RM price hike in

previous year



Checks Expense items Any abnormal increase in any item

RM price movement ² is it adequately reflected ? Cross check

Sales returns ?

Increased selling expenses ?

Bad debts write off levels ?

Service charges to group companies ? Or companies where management has interest

Interest component ² check with average debtand prevailing cost of debt Has a component been capitalized ?

Has the firm taken unsecured loans ?



Checks Depreciation ² high ? Commensurate withproduction ?

Does the depreciation in OS and BS match ?

Is lease amount charged to P&L ?

Commission on sales, royalty payments

Is the money being taken out ?

Increase in salary to directors ? ² in line with sales ?

Dividend payment

Is it from operational profits ? Dividend ² when profit is from non operating income

?

Is it from reserves ?

Borrow to declare dividend ??

Interim dividend ?



Checks Networth

Reserve { cash

Knock off

Revaluation reserves Intangible assets

Water drawing rights ??

Prequalification rights ??

Marketing know how ??

Drawing and designs ??

Debenture redemption reserves

Advances to group companies

Investments in group companies

Any unrelated investment ( except short terminvestments)



Checks Miscellaneous expense not written off

Deferred revenue expenses

Book debts unrecoverable ² but not written off

Contingent liabilities ² not arising from normalbusiness

Share application money received ² but notallotted

Is it truly worth ??? How has the networth numbers moved?

Accumulated profits correctly added ?

Any charge offs directly from reserves withoutrouting thru P & L ?



Checks Contingent liabilities as % of TNW

Check nature of these liabilities

Claims against the company not acknowledged as debt !

IT claims, tax dues ?

Land acquisition claims

FY Total Contingent

Liabilities (TCL)

TNW TCL as % of

TNW

Essar Steel Ltd Mar ·05 1,900.98 713.56 266.41

Container Corporation of India Ltd Mar ¶05 17,559.50 1,823.04 963.20

Gammon India Ltd Mar ·04 977.07 361.79 270.07

Skanska Cementation Ltd ² Formerly,K

vaerner Cementation India Ltd

Mar ¶04 567.64 51.16 1,109.54



Checks Charging off directly from reserves «

Zee Telefilms Ltd (Rs. in Crores) 2005 2004 2003

Paid up Capital 41.24 41.24 41.24

Total Reserves 2,095.52 2,005.32 3,865.44

Opening Balance of Share Premium Reserves 1,367.68 3,288.21 3,509.58

Less: Goodwill 0.00 0.00 160.15

Less: Diminution in Investment 0.00 1,920.53 61.22

Less: Expenses on FCCB Issue 11.85 0.00 0.00

Less: Premium on FCCB Redemption 13.18 0.00 0.00

Total Deductions««««««««««««««««. (A) 25.03 1,920.53 221.37

Closing Balance of Share Premium Reserves 1,342.65 1,367.68 3,288.21

Reported Profit After Tax (RPAT)««««««««««(B) 162.27 118.37 94.34

A as % of B 15.42 % 1,622.48 % 234.68 %

Cumulative RPAT since 2003 372.02 209.75 94.74

Cumulative Deductions since 2003 2,166.93 2,141.90 221.37



Checks Inflation of networth Advance from promoters to associates towards

promoter·s contribution

Equipment supplier / contractor subscribing toequity - by inflating cost

Equity issue for anything other than CASH ? Equity issue against property ? Check break up of advances, book debts ²along

with age and purpose Examine auditor·s comments How are the dividend payouts ?



Checks Deferred tax liability

Provision made to off-set benefits of tax shelter companiesnormally get ( eg : WDV as against SLM method ofdepreciation)

Lowers networth

Deferred tax asset

Arises as a result of human judgement of future profitability!

Increases networth

Sometimes impact can be significant. On a conservativestance ² consider DTL and ignore DTA



ChecksImpact of deferred tax liability / asset

Company FY Actual TNW Net DTA TNW per AS

Dharani Sugars & Chemicals Ltd Mar ¶04 2.89 23.28 26.17

Indian Seamless Metal Tubes Ltd Mar ·04 26.38 50.59 76.97

Jain Irrigation Systems Ltd Mar ·05 149.06 74.32 223.38

Orient Paper & Industries Ltd Mar ·05 - 35.98 37.45 1.47

Whirlpool India Ltd Mar ·05 - 4.32 58.38 54.06

Mangalore Refinery & Petrochemicals Ltd Mar ·04 823.02 590.45 1,413.48

Company FY Actual TNW Net DTL TNW per AS

Automotive Stamping & JBM Tools Ltd Mar ¶04 12.15 4.83 7.32

Flex Industries Ltd Mar ·04 66.74 26.38 40.37

GSFC Mar ·05 233.16 95.09 138.07

Chennai Petroleum Mar ·05 801.43 204.47 596.97

Essar Steel Ltd Mar ¶05 786.02 195.87 590.15



Checks Loans

Secured ?

Short term ² why ?

Long term

Check capex incurred

Source ? Purpose ?

Unsecured

From promoters ?

What is the interest drawn ? What is the trend over the years ?

From other sources

Why ? And at what interest rate ?



Checks Check cash accrual / total term debt

Counter check with repayment schedule

Check LTD / TNW

Check Total debt / TNW

Any interest accrued and due ?

Preference shares ² non convertible ? Cumulative ?

Equity or debt ?

Working capital funds

Quantum LC utilization

Any overdrawings ?

Current liabilities «.more than current assets ?

What is the firm·s business ?



Checks Assets

Tangible fixed assets , intangible fixed assets

Acquiring assets (from group firms) to square off

debts ? Loss capitalized ?

Interest

Forex losses capitalized

Pre-operative expenses capitalized (components )

Capital work in process Will they work ??



Checks

Investments

Why ? And in what ?

Examine variations over years



Checks

Current assets

Current ?

inventory

Check aging How is the holding period trend

Valuation methods ² any change

Advances to group companies

Check trend over years What is it as a % of TNW ?



Check

Check for overvaluation of stock Step 1: Effective Cost of Sales = Total cost of sales before interest &

depreciation

(ECS) Less: Selling & distribution expenses

Less: Sale of scrap

Add: Depreciation

Step 2: (ECS / Net Sales) * 100 = Ratio for assessing Closing Stock Values (RCS)

Step 3: Apply RCS to value of sales of each product as given in notes to

accounts to arrive at the Real Value of Stocks (RVS)

Step 4: Compare Actual Closing Value of Stocks with RVS and note the

Difference Value (DV)

Step 5: Multiply DV with the quantity of closing stock for each product to get

Over-Valuation of each product. Aggregate all such values to get the

Total Over-Valuation (TOV) of closing stocks by the company



Check

Units sold SalesRevenue

Rs.Crores

Revenueper Unit

Rs.

ClosingStock (Qty)

ClosingStock Value

Rs. Crores

ClosingStock Price

per Unit(Rs.)

Over Valuation

Rs. Crores

4 * (6 ² 3)

1 2 3 4 5 6 7

FY 2004 (Data on Jewellery and Coins products were combined in balance sheet )

Jewellery 12,66,056 423.80 3,347.42 1,10,632 67.98 6,145.33 30.95 Crores

2005 FY 2005: (Data on Jewellery and Coins Products given separately in balance sheet for both theyears)

Coins 5,12,143 73.14 1,428.05 36,897 4.43 1,200.64

Jewellery 4,32,745 458.34 10,591.48 1,39,877 119.85 8,568.24

Total 9,44,888 531.48 5,624.79 1,76,774 124.28 7,030.45 24.85 Crores

2004 (Restatement of FY 2004 figures in the balance sheet of FY 2005)

Coins 3,96,416 51.71 1,304.44 24,606 1.81 735.59

Jewellery 8,69,640 372.09 4,278.67 86,026 66.17 7,691.86

Total 12,66,056 423.80 3,347.40 1,10,632 67.98 6,144.696 29.36 Crores

Titan Industries Ltd



Check

Non current Those which are not sold / disposed /

realized within a year / operating cycle Receivables over 180 days

Rent deposits and other such deposits

Margin monies for BGs

Advances to staff, directors, group companies

etc Advances for capital goods



Key ratios Operating profit margin

Net profit margin

RM / net sales ( or total cost), fuel cost / net sales, labour cost / net sales

Interest coverage ratio Dividend payout ratio

Debt / equity

Net cash accrual / total term debt

Net cash accrual / total debt

Total outside liabilities / tangible networth

Current ratio

Cannot indicate cash generation

Inventory ( RM, WIP, FG) holding periods

Average collection period



Key ratios Fixed asset turnover ratio

Sales / operating fixed assets

Low ratio ( less than 3) , to be checked Varies with industry

Technology outdated ? Low Networking capital , can be borrowing intensive

Profits likely to be low

Capital turnover ratio Sales / capital employed

Around 5 is reasonable level Current asset turnover ratio

Sales / operating current asset

Indicates quality of inventory and collections



Key ratios

Debt service coverage ratio

PAT + depreciation + non cash items + interest

Interest + Annual Loan Instalments

Average of 1.5 desirable

If lower ² re-phase repayment schedule



Beyond the financials

Management Nature

Constitution

Professional ? Experienced ? Family members ? Hands on or hands off ?

Risk appetite

Strategic vision

Intention and integrity ???

Financial discipline

Regularity in payments

Information flow

Corporate governance (??)




Industry What phase of growth is the industry in ?

Structure ? Domestic and international competition

How regulated ? ² how is the policysupport ?

Outlook

How big is the industry ?



Beyond the financials Business

Unit

Access to key inputs ( will he get the gas ?? ), tomarkets, to labor , power

Minimum economic size Scope for expansion ?

Availability of inputs ,

Number of suppliers and relationship

input substitutes,

terms of availability,

international position, volatility of prices ( and howit is hedged)

Duty structure




Position in a market ( market share)

Nature of customers

Size, number , contribution per customer

Price structure ² regulated ( at what price will he sell the gas !! )

Tenor of relationship with them

Alternate products ?

Exports

Nature of the country

Comfort with banks in the country

Currency and volatility




Transaction Nature of facility requested

Working capital Revolving lines ???

Bills / other self liquidating lines

Exit / take out options available

Term debt

For what ? Capex ? Or opex ?

Total cost of project and means of finance

Necessary approvals in place ?




Term debt

What is the promoter·s margin

Has it come / how will it come

Technology availability

Supplier of equipment

Related ???

Warranty ? Replacement possibility ?

People to run it ??

Are the prices reasonable ? Any gold plating??

Schedule of implementation

Will the project pay on its own and will the firmhave cash to pay even if the project fails ?



Credit rating

Why ?

How ?

Internal / external ?

CRISIL , ICRA, CARE , FITCH, Brickworks

appraisal - mbfi

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