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Mid Term Progress Report

Financial Statement Analysis & Credit Assessment

Allahabad Bank

Mid Term Progress Report

Objectives: The primary & broad objective of the report is to understand the process behind the Financial Statement Analysis of Companies for the purpose of Credit Assessment. The rationale followed for assessing the credit risk of the borrower so as to be able to take the sanctioning decision and the pricing of the credit facility. The project also aims to deal with the key factors involving the Fundamental Analysis that is carried out by the bank for the same purpose. Identifying the bank rationale behind its reliance on external agency reports and Lead Bank assessment in case of Consortium Lending. The project will aim at identifying the guiding points, as per the banks lending policy, which enables the banks analyst to zero in on the true and fair picture of the Company under assessment. The secondary objectives of the project would include familiarizing with the policies adopted by the banks for the purpose of assessment, which may be in aberration with the theory. And, to understand the practicality of the process so as to be Job-ready. The main sections of the policy covered will be, Exposure Management; Credit Risk Management o External Rating o Hurdle Rates Margin; Security; Timeframe for Disposal of Proposal; Pricing; Documentation; Loan Syndication; and

Financial Statement Analysis & Loan Assessment

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Mid Term Progress Report

Methodology:

Rejection of Credit Proposals; and Deviations from the Stipulated Policy.

Financial statement analysis the process of understanding the risk and profitability of a firm (business, sub-business or project) through analysis of reported financial information, particularly annual accounts.

The methodology followed for undertaking the project follows the simple rationale of do & learn. Different, actual cases of Credit Assessment have been taken up to achieve the objectives of the process. In totality 4 different companies from different sectors would be taken up and an analysis based on the Banks Lending Policy (an internal document of the bank) will be done. The actual assessment done by the banks analysts would be scrutinized for any aberration from either the Banks Lending Policy or Basic Theory of the subject. It, sometimes may be so that owing to different practical reasons the basic theory may not be followed for taking sanctioning or pricing decisions. Such cases form a very important part of the report as they give a hard-line view on how the theory may not be enough for an analyst to complete the assessment and take decisions. As per the Banks Lending Policy for basic Financial Statement Analysis the emphasis is on the following heads, Gross/Net Sales; Net Profits; Paid Up Capital; Tangible Net Worth; Net Block of Fixed Assets; Non Current Assets; Liquidity Ratio;
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Financial Statement Analysis & Loan Assessment

Mid Term Progress Report

Leverage Ratio; Contingent Liabilities; and Debt Service Coverage Ratio (DSCR).

Among the above items, much emphasis is placed on DSCR. The Debt Service Coverage Ratio (DSCR) is the amount of cash flow available to meet annual interest and principal payments on debt. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough cash flows available to cover 95% of annual debt payments. Signifying, that the firm will not be able to repay back its debt obligation and thus obviously becomes a loss making proposition for the bank. The Trend Analysis of the items from the Income Statement and Balance Sheet (such as Gross Sales, Tangible Net Worth etc.) would be done for arriving at the true and fair picture of the state of the company and more importantly for Credit Assessment - its future performance.

For Term Loan Assessment, a Fundamental Analysis of the firm becomes crucial and an assessment of the following is done, Financial Risk; Business Risk; Management Risk; Industry / Activity Risk;

Thus for the 4 Cases such assessment would be done to arrive at the credit worthiness and future performance prospects of the borrower. Hence, broadly the Banks Lending Policy and Theory of the subject will be implemented to identify the process of assessment for, Fund Based Facilities, o Working Capital Finance,
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Financial Statement Analysis & Loan Assessment

Mid Term Progress Report

o Term Loan Non-Fund Bases Facilities, o Letter of Credit, o Bank Guarantee, etc.

Progress Till Date: Substantial portion of the theoretical part of the project, which includes, Introduction of the Project; Objectives of the Project; Basic Methodology of the Project

Has been completed as it forms the base for the project. While, the assessment of two of the 4 Companies has been completed. These, companies belong to Power Sector and Textile Industry. As asked by the Project Guide, the Companies need to be kept anonymous, hence for the sake of reference they have been named as Power Equipment Company Limited and Textile Limited. The third company is a trading concern, assessment for which is under process. The third company will be referred to as Trading Limited. The fourth case has not been selected as yet, but will belong to a different industry than the above three.

A brief analysis of the two companies is as follows, Power Equipment Company Limited: Gross Sales: The Company achieved a Gross Sales figure of Rs. 1285 Crore in FY 2010-11, a growth of 75% over previous year figure of Rs. 735 Crore. The rise in sales could be attributed to the sales of Cables (LT & HT) which grew 2.5 times to Rs.512.52 Crore from Rs. 203.15 Crore (accounting for 40% of the revenues) and that of Transformers which grew by 86% to Rs.254.31 Crore. The company has attributed the spike in the revenues on the rise in demand for HT Cables, and aggressive bidding by the company in the Transformers segment to gain more orders.
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Financial Statement Analysis & Loan Assessment

Mid Term Progress Report

The Company has estimated a similar growth of 73.3% for the next year, FY 2011-12. Estimated gross sales figure as stated by the company comes to Rs. 2223 Crore. The company claims to be an integrated player in the Power Equipments market and is aggressively looking for expansion of operations; it also boasts of a robust order book that can help the company achieve the estimated target.

Profitability: The Company had Net Profit (After Tax) of Rs.50.57 Crore in 2009-10 which grew by 93% to Rs. 97.62 Crores in 2010-11. The overall Net Profit Margin of the company bettered from 6.8% in 2009-10 to 7.5% in 2010-11. The improvement in margin was on account of the improvement in margins for the Cables segment which comprise 40% of the revenues. For FY 2011-12, the estimated Net Profits are Rs. 138.04 Crores, an increase 41% over previous year and Net Profit Margin of 6.2%. The decrease in margins can be attributed to the rise in borrowing cost being incurred by the company on its Term Liabilities as it is taking up various expansion programmes. All other costs are estimated to stay on the same lines as previous year.

Paid up Capital: The Share Capital of the company underwent various changes in FY 2010-11, as the company allotted 55,93,727 shares under QIP and 8,83,217 shares under Preferential Allotment. Further, share warrants issued previous year were converted into 20, 00,000 shares. Hence, the Paid up capital of the company grew to Rs. 37.2 Crores from Rs. 28.06 Crores in FY 2009-10. The Paid up capital is estimated to be same as current year in FY 2011-12.

Tangible Net Worth: With the issue of fresh equity in FY 2010-11 the Tangible Networth also went under substantial change and grew by 73.69%. The Company accumulated reserves under Securities Premium A/c by Rs. 128.98 Crores and also retained a large part of the profits (dividend payout ratio being 13.6%). In FY 2011-12 the TNW is estimated to grow at 25% as the company is planning on retaining a large chunk of the profits to boost its Balance Sheet.

Financial Statement Analysis & Loan Assessment

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Mid Term Progress Report

Net Block of Fixed Assets: The Companys Net Block of Fixed Assets grew around 92% to Rs. 248 Crore in FY 2010-11 forming 22.3% of the total assets. The growth was on account of completion of the several expansion programmes by the company. In FY 2011-12 it is estimated that the Net Block will again grow by 54% owing to the completion of further expansion projects, at the present manufacturing facilities of the company, which are currently underway.

Non Current Assets (Covering Investments): Non Current Assets of the company grew by 45% to Rs.53.52 Crore in FY 2010-11 and more than double to Rs. 109 Crores in FY 2011-12 owing to increase in exposure of the company to its subsidiaries both in terms of equity investments and loans.

Liquidity Ratio: The Current Ratio of the Company is improving over the years from 1.39 in FY 2009-10 to 1.45 in FY 2010-11 and to 1.49 in FY 2011-12 (estimated), signifying comfortable liquidity positions.

Leverage Ratio: TOL/TNW ratio of the Company improved from 1.5 in FY 2009-10 to 1.2 in FY 2010-11 due to the issue of fresh equity by the company and a substantial retention of profits to augment the Tangible Net Worth.\ But, it is assumed to go up to 1.5 again in FY 2011-12 with the company planning to increase its liabilities.

Contingent Liabilities: The contingent liabilities of the company are mainly comprised of LCs amounting to Rs. 114.52 Crore & BGs worth Rs. 94.87 Crore. There are no tax liabilities under dispute. Corporate guarantee issued to wholly owned subsidiary Diamond Power Transformers Ltd. amount to Rs. 60 Crore.

Debt Service Coverage Ratio (DSCR): The DSCR of the company in FY 2011-12 is 1.59 and will go up to 1.98 in FY 2012-13 on account of increased profits. And, will be

Financial Statement Analysis & Loan Assessment

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considerably high for the period under consideration. The average DSCR (Up till FY 202021 will be 1.83). Thus, signifying a strong financial standing of the company.

Strengths Integrated player in the market as the product range covers more than 80% of equipments requirement for EPC projects. Long history of performance in the same industry. Company is constantly expanding and modernising to cater to the market demand and face competition. Excellent Sales growth rates mainly on account of Cables, which will be undergoing capacity expansion. Comfortable EBITDA margins on all products in the range. Favourable liquidity position of the company throughout. Comfortable Debt Service Coverage ratios signifying a strong financial standing of the company.

Weaknesses Capital intensive segment. Raw Materials (aluminium, etc) are prone to fluctuations in the market. Even though the company enjoys comfortable liquidity positions there is a huge gap between Receivables Days of Holding and Creditors Days of Holding, 60 days and 24 days respectively. If escalated, may bring in problems for the company. Cash Accruals which are supposed to cover 21.6% cost of the expansion project cost may be hit if profits tumble.

Textile Limited: Gross Sales: The Sales of the company have been growing in the past at a handsome pace Y-O-Y. In 2010 it grew by 92% and in 2011 by 37.75% to come at Rs. 3667 Crore.

Financial Statement Analysis & Loan Assessment

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Mid Term Progress Report

But owing to a demand supply mismatch in the year 2012 the sales could grow only 4.27% to come at Rs. 3824 Crore. Profits: The profits of the company grew by 27.45% in 2010 and 39.01% in 2011 and the Net Profit margins of the company bettered from 2.51 in 2010 to 2.58 in 2011. Even though the companys revenues grew in 2012 it faced losses amounting to 90% of its profits in 2011. The loss was mainly attributed to the rise in Power, Employee and Financial Charges cost. Paid up capital: The paid up capital of the company, in absolute terms, has remained constant over the years. As a percentage of Total Liabilities it came down from 1.95% in 2010 to 1.50% in 2012 owing to the increase in operations and the Balance Sheet size of the company. Tangible Net Worth: Tangible Net Worth of the company grew by 16.7% in 2011. The dividend payout ratio was around 9% in 2010-11. Hence, a major chunk of the profits are being retained by the company increasing its Tangible Net Worth. However, the TNW of the company depleted by around 14% in 2012 owing to losses faced by the company. Net Block: Net Block of Fixed Assets of the company grew by 4.8% in 2011 and by 39.4% in 2012 Y-O-Y. While come to around 56% as a percentage of the Total Assets of the company in 2012 as compared to 48% in 2010. Signifying, a decrease in the levels Current Assets in comparison to the Net Block. Non Current Assets (Covering Investments): Main components of Non Current Assets include investments in group concerns which is constant over the years and debtors over 6 months which rose in 2011 by 72.27% to Rs. 9.08 Crore. The company assumes there will be no such debtors at the end of the year 2012. Liquidity Ratio: The current ratio of the company has improved marginally from 1.15 to 1.18 (2010 to 2011) mainly due to steep rise in Inventory. In 2011-12, also, the current ratio stays at 1.18 even though the liabilities of the company are increasing and Total Current Assets are decreasing on account of a steep fall in inventory levels, as it is assumed that the principal payment obligations will be put on hold and a moratorium period be allowed to the company in the wake of the current downtrend situation.

Financial Statement Analysis & Loan Assessment

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Mid Term Progress Report

Leverage Ratio: The TOL/TNW ratio has increased from 3.01 to 3.24 and will go up to 3.96 in 2011-12 as the company will be taking fresh Term Loans & Working Capital finance to tide over its liquidity problems. Also, as the company faced losses amounting around Rs. 79 Crore, there has been a depletion of its Net Worth, pushing the ratio up. Contingent Liabilities: The contingent liabilities up to the end of the year 2011 amount to Rs. 117 Crore. The amount is in dispute under the Central Excise Tax, 1944 and Gujrat Sales Tax Act, 1969. It could have large impacts on the profitability of the company even if partially recognised. Debt Service Coverage Ratio (DSCR): The DSCR is the amount of cash flow available to meet annual interest and principal payments on debt. The DSCR of the company in 2009-10 was .94 and in 2010-11 was 1.0008, but as calculated it will go down to 0.27 in 2011-12 as the company is facing unexpected losses during current financial year. The average DSCR for the complete tenor (that is the period for the financial restructuring plan being proposed by the company) also comes to about 1.14 only and 1.31 during repayment period (that is after a moratorium period of 3 years). And it will be more than 1 from the 3rd year onwards.

Strengths Significant product range with presence in chips, yarn and fabric business. Leader in Polyester Filament Yarn (PFY) based textiles and second largest speciality yarns maker in India. Long history of performance of the company. The revenue growth of the company was slow in the previous year but the industry conditions are supposed to better in the coming period. The company is adopting coal fired power plant reducing its power expenses and improving the profit margins.

Weaknesses The company faces a 2% disadvantage over competitors from outside Gujrat on account of CST Loading. In 2012, the company faced losses amounting to 90% of its profits in 2011. The loss was mainly attributed to the rise in Power, Employee and Financial Charges cost.
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Financial Statement Analysis & Loan Assessment

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The company is currently highly leveraged with the TOL/TNW ratio being 3.96, contributing to the fixed charges on the company. The DSCR of the company is below one for the year ended 2012 and 2013 signifying negative cash flows. Even after 2013, it takes considerable time to come at comfortable levels, becoming 1.41 only in 2019-20.

The financials of the two companies are in the accompanying Microsoft Excel file named Input LCM Power & Input LCM Textile respectively. The final report would include a detailed profile and analysis of the accounts of the companies along with the relevant information for each case (such as product information, plant information, etc). Remaining Work: As the theoretical part of the project has been completed substantially, only the two other companies assessment remains. The third company Trader Limited accounts analysis is under process and will be completed soon. The fourth case has not been selected yet, and will be selected after the completion of the current case. The Banks Lending Policy scrutiny will also be completed in the meanwhile. Conclusion: The curent progress in work is satisfactory and ensures the timely completion of the project.

Financial Statement Analysis & Loan Assessment

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