Learning To Fly

Schlafhorst Engineering (India) (SEIL) is one of the few multinational companies whose track record can make any investor nervous. It makes textile machinery, one of the worst hit sectors when import duties fell consistently post-liberalisation. Worse still, SEIL competes with its parent company for some strange reason and little can be done immediately to change this.

Further, it has spent the last four years in red for reasons apart from those mentioned above. And hence when it made a Rs 6.46-crore rights issue (for nine per cent cumulative convertible preference shares, convertible after six years of allotment) in August 1996, we were negative about its prospects.

 

But something has changed between then and now. And it is not for nothing that the stock has shot up 2.5 times from Rs 14 to Rs 35 since mid-December. The bourses have sensed that the company is doing something radical which is beginning to bear fruit. For instance, after three years of mounting losses, it cut losses by Rs 5.35 crore for December 1996. In fact, there is a good possibility of the company posting a net profit this year. The Budget has

also showered benefits by lowering import duty on machinery components.

The sentiment for the stock also received a boost since the textile sector picked up in the last one month. In fact, the biggest player in the sector, Lakshmi Machine Works saw its stock jump 25 per cent to Rs 6,250 in less than a month. On the user front, cotton yarn exports have picked up recently.

So one thing is clear: the textile industry appears to be on an upswing. The question is whether SEIL can make the best of it.

Frankly speaking, the first signs of turnaround should have appeared when the company became a part of the Switzerland-based Saurer AG group. But the key change only occurred when Josef Steiger was appointed as a representative from the Saurer group on the board of SEIL in January 1996. Now, Steiger, a textile engineer has a reputation of being a turnaround artist. As one analyst puts it, Steiger is a fanatic when it comes to cost

cutting.

Already the company has cut commission payable to its marketing arm (where it holds a one-third stake) from about 3.5 per cent to 1.75 per cent with retrospective effect, cut salary paid to the chairman and cut input costs with higher levels of indigenisation. This will also reduce costs.

However, last year the bulk of the savings came from a huge drop in operational expenditure. In 1996, sales grew by Rs 20.56 crore to Rs 55.49 crore while expenditure grew slower at Rs 13.87 crore to Rs 52.03 crore. Operating profit went up to Rs 3.05 crore in the second-half of 1996 from Rs 0.41 crore in the first-half. Some high-interest bearing loans were swapped with loans from the parent company at nominal rates. Hence, interest charge fell in the second half.

For 1997, interest cost will fall further and operational costs will be cut by a couple of crores. However, Steiger looks at it very differently. His aim is to minimise losses suffered in selling autoconers which account for bulk of the company's business value.

Put differently, Steiger wants to break-even SEIL by selling 40 autoconers. And whatever profits that come from selling draw frames and textile machinery spares (where the company enjoys higher margins) will reflect at the net level. But achieving this will not be easy. Also there are limitations to cost cutting measures in the long run. For instance, the VRS which it recently offered to its employees flopped.

However, there are a few factors which could swing things in favour of SEIL. Currently, the domestic market for autoconers is roughly 400 pieces a year. And the average value of the autoconer ranges from Rs 0.7 crore to Rs 1 crore. The local market for autoconers is big, but can be bigger provided textile mills take up modernisation seriously. Out of the operating capacity of about 25 million spindles, roughly 20 per cent is equipped with autoconers. The use of autoconers in EOUs is a must. So demand from them is definitely going up.

But the last few years have seen a rise in imports of second-hand machinery. Most of the second-hand imports comprised the 138-autoconer manufactured by Schlafhorst, Germany. It must be known that SEIL's parent makes the best autoconers in the world. Apart from these, many EOUs also preferred to import directly from SEIL's parent (the parent sold about 100 autoconers in India last year) and if not that, source it from Murata of Japan or Savio of Italy. The past, however, does not equal the future.

SEIL will benefit on three counts. One, a gradual rise in the demand for autoconers and a simultaneous reduction in second-hand machinery imports. Here the impact on SEIL will be diluted since Murata and Savio also are big players in India and their machines are cheaper. Murata is a bigger threat. But there are enough cotton yarn producers who are not so happy with Murata machines. So that could work to SEIL's advantage.

Two, competition from the parent could reduce. So far, SEIL's focus was on the rupee market for autoconers. It was not possible for Schlafhorst, Germany to cut back its production owing to strict labour laws. Not that it is easily possible now, but Schlafhorst, Germany has introduced a new autoconer, 383 whose production cost is 30 per cent less than its previous model, 283. So the best-case scenario could run like this: The production of 283 (which currently is being made by SEIL at its plant in Baroda) shifts completely to India (also since India is a big market for these machines). And Schlafhorst, Germany will take up production of 383, since this will give them higher margins. Currently no player is making much money in autoconers.

Three, as mentioned earlier most of the second-hand machinery which was imported in the last few years comprised the 138-autoconer. Demand for spares from this segment will be higher in the coming years. And then if supply of spares for 138 is centralised in India, nothing like it. Last year, SEIL's sales from spares stood at Rs 6 crore. The figure in 1997 will be much higher, at around Rs 10 crore.

Much of what is said above is likely to transpire over the next couple of years. In fact, one big reason as to why the stock would have ultimately done well is the increased level of commitment from the parent in the form of both people and money and the fact that India is important. So one thing is for sure. SEIL's happy days have just begun.