November 2: Telco's first-half results can be considered as one of the worst performances in the recent past. Still, the stock managed to hold itself and did not record any major fall. One reason for this could be market expectations -- the market was expecting these results and the stock price had already dipped by over 25% within two months prior to the results.

Even then, considering the results, the stock performance appears commendable. For the six months ended September, 1997, Telco's sales dropped by 17 per cent from Rs 4,661 crore to Rs 3,840 crore, while net profit stood at Rs 213.93 crore, down 35 per cent. The drop in earnings would have been even greater had it not been for the tax breaks which Telco earned on its investments. In fact, investment in the small car project has resulted in the effective tax rate dipping from 30.05 per cent to 16.08 per cent, which is reflected in the tax provision of a mere Rs 41 crore.

On the offtake front, the MCV and HCV segments have been the hardest hit. This is reflected in the 31.7 per cent drop in sales in this segment for the period from April-August 1997. With a 40 per cent growth, Sumo was the only saving grace. Profit margins at the operational level have fallen from 14.12 per cent to 12.32 per cent despite an inventory build-up, which contributes positively to the margin, but is profit neutral. Undoubtedly, the such a performance deserves a strong beating in the stock market. But this has not happened; does this mean that the worst is over for Telco?

According to the company, an improvement in demand is expected in the second-half. Besides, the company has also taken some measures to reduce cost and improve efficiency. Although the positive credit policy has raised hopes for industrial recovery, huge inventory figures for the six months ended September 1997 continue to bother the market.

Telco's inventory of finished goods as on September 97 stood at 19,969 units (around 20 per cent of the total production), up 300 per cent from 6,658 units in the corresponding period last year. Thus, even if demand improves, the high inventory will force the company to cut production to a great extent, which in turn, will affect operating margins. Going by the first-half figures, the company has to cut production by around 30 per cent in the second-half to wipe off its inventories.

Another area for concern is the company's small car project. Having already pumped in Rs 300 crore into the project, the company has earmarked a capex of Rs 1,700 crore. Telco's management has itself stated that it is likely to achieve a breakeven at 60,000 units, which could take over two-and-a-half to three years to achieve. Thus, the losses from the `Indica' will have to be absorbed by Telco, which will further erode earnings. And, fighting with Maruti Udyog on the pricing front will not be a easy task.

The tight cash flow position will also adversely affect Telco. Last year, the company was unable to control its working capital requirements. During 1996-97, the company had a negative cash generation. RONW also dipped to 25.15 per cent from 27.70 per cent in 1995-96. The working capital turnover ratio, in fact, declined from 8.35 times during 1995-96 to just 4.2 in fiscal 1996-97. The cash generated before meeting the working capital requirement was Rs 1402.21 crore, but the increase in working capital requirement was Rs 1401 crore. Thus, the need of additional funds will definitely affect the future cash flow of the company, besides affecting the interest burden. As such, high inventory, no sign of improvement in demand and the additional requirement of funds will continue to affect Telco. The market will have no option but to show a bearish approach towards the stock, unless the company records some magical figures in the second-half.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.