March 2005
COVER STORY

Growth of Corporate Nepal
WHERE and HOW?

BY Madan Lamsal and Keshav Gautam

Major indicators from corporate Nepal show that it has learnt a lot about how to adjust itself to the changed situation.

With the publication of the audited annual reports of a number of companies, it is worth your while to take a stock of how Nepal Inc. has fared during the last fiscal year that ended mid-July 2004.

As seen from the information presented in the tables on this report and the brief analysis of them, corporate Nepal was not doing as badly as feared. The lack of peace has not affected some businesses at all. Even in the sub-sectors directly affected by the security problem the severity of the impact varies widely from one sub-sector to the other and one company to the other. Most of the companies analysed, it seems, managed not only to live with the security problem but also registered growth.

Many companies, including some prestigious ones, are still to bring out their reports. The delay in most cases is because the companies’ performances are not up to the mark and they do not want to disclose the report to the general public including their shareholders. Perhaps they are busy with window dressing. Therefore it can be concluded that the reports of such companies do not reflect the true performance of the Nepali corporate world. Their bleak performance is the result of the managerial problem, which is endogenous to the company, not exogenous. So, this is contrary to the claims by some captains of the business community who are pleading for moratorium on repayment of bank loans. However, this generalisation may not hold true in case of hotels where the reasons for reduced business and profitability are obviously exogenous.

While comparing the performance of the companies that have already come up with their annual report, it can be noticed that the financial sector companies are doing better than in the previous year, though a few of them reported reduced level of operation as reflected in their deposit mobilisation.

One conclusion that can be drawn by comparing the annual reports of the companies for the year under review is that there is a need to change the practice of the analysts to take the performance of the banks as a proxy for the performance of the business-industries. Though the banks have reported higher incomes and profits in general, the increase is not due to investing in the industries and businesses.

Most of these banking and financial sector companies have reported reduced flow of credit to the corporate clients. How the manufacturing sector managed to remain steady despite not a noticeable increase in the flow of bank credit to this sector demands a separate detailed research. It surely indicates that the manufacturing sector has effected some readjustment in itself over the last couple of years.

These banks have managed higher profits by consumer lending—a business the central bank has turned a Nelson’s eye to despite the fact that such loans in Nepal means consumption of imported items, thus putting pressure on the country’s balance of payments. The central bank’s opinion for the time being is that such lending has been helping the banks to overcome the problem of excess liquidity. It means that the central bank will not intervene in this business of the banks till there is big surge in the imports and/or demand for credit by the business sector.

Among the commercial banks, all the three indicators used in this analysis (deposit collection, interest income and net profit) have recorded a massive jump in case of young companies while they are a bit slow as the company ages. Though there are some exceptional cases of reduction in the net profits, this is explained by hefty provisions that they were required to make for bad loans. As this has improved their financial health, the coming years will be good for these banks too.

However, it seems that the finance companies have been facing more problems. While the young ones may be found expanding their businesses, the relatively old ones have experienced slowdown or even decline. As the report of the National Finance Company Ltd. (NFCL) says, the company was forced to deliberately reduce the deposit collection because the demand for loans had declined. Even in companies that have reported increase in the deposits, the increase is marginal. Similar is the situation in their interest income. Also the profitability of such old finance companies has flattened. Apart from the reduced loan demand, the other cause for such a situation is the new rule that requires finance companies and banks to make provisions for the amount of equity they hold in other banks and finance companies. As is well known, one major investment of these finance companies was in the shares of the commercial banks and other finance companies. All these investments, however, will be liquidated at a much higher amount than their book value because the commercial banks are doing well in terms of profitability and the prices of the shares of these banks are rising in the stock exchange. Therefore it can be said that the finance company sub-sector are also doing well.

The worst performance across the sectors is reported by the hotel industry. Two of the three hotel companies operating five star properties, of which the performance highlights are available and presented in this analysis, have reported losses despite marginal improvement in room occupancy. One major reason for this is the increase in fuel prices, which are administered by the government. Similar is the situation in other five star as well as other category hotels, disclose the owners of such properties during private conversations. The authorities sealed the accounts of two hotels early March accusing them of default in tax payments, which, as can be understood, is because of cash flow problems. Of course there are some exceptional hotels, which are dealing with some niche markets and doing all right. But such exceptions are very few. This situation is expected to deteriorate further in the current fiscal year as the governments of tourist originating countries have not yet changed their negative travel advisory about Nepal.

Also the trading sector (represented by Salt Trading Corporation Ltd) is performing not so bad. However, in the manufacturing sector, the performance is mixed. Three companies (Nepal Vegetable Ghee Ind., Khadya Udyog and Gorakhkali Rubber), the reports of which are presented here, belong to the Salt Trading Corporation Group and it can be seen that two out of the three have improved their performance in the review year as compared to the previous year.

Another category of companies reporting reduced profitability is that under which fall the companies who rent out space for shops or offices. Bishal Bazar Company Ltd. has marginal increase in its rental income. Its operating and net profits were, however, reduced due to the increase in expenses—mainly on electricity. The five star hotels that rent out space for shops and offices have reported reduced rental income too.

One noticeable feature in the manufacturing sector is that while those companies in the personal care sub-sector are doing fairly well, those in the soft drink sub-sector have reported flat sales. In personal care sub-sector, the two companies from which the annual reports were available are multinationals. This fact may also indicate that the complaint of unusual circumstances, in the year 2003-04, is only an excuse: a company with good managerial acumen and ready to make the necessary changes as demanded by the situation can not only survive the unusual circumstances, it can even grow despite it. Interestingly, the reports from these companies show that their growth in profitability came not from exports but from domestic sales.

The companies that are very much dependent on exports (such as those producing vegetable ghee) have also reported increased sales and increased profits (or reduced losses). This is remarkable in that the vegetable ghee companies in the review year had faced frequent problems in exporting to India, the market where the major share of their sales are made. Also the Jyoti Spinning Mills, a company that depends significantly on exports to India, has reported higher profit despite reduction in total sales. Clearly, either the productivity is improving in those sub-sectors as a whole or expense management is becoming further refined. Both are good signs.

In the soft drink sub-sector, the reports available were from two companies of only one brand—Coca Cola, an aerated drink. The sales of this brand in the review year was almost flat. This brand was specifically targeted by the terrorists in the year under review. However, indications from the substitute brands of soft drinks confirm flat sales in this category. Dabur Nepal produces and sells fruit juice (which can be considered a near substitute for aerated drinks) and this company’s report shows almost flat sales in this product (an increase of only about 400 kilo litre or Rs. 122 million over the previous year). In the beginning of the ongoing fiscal year, the domestic production of Coca Cola was forced to be closed for almost a month. That raises fears that the performance of these Coca Cola companies is not going to be much better in the current year. But as this year’s season for soft drinks has just started, there is still hope for these companies to improve their performance this year. However, it is surely going to depend on how effective the security situation will be during this summer to allow easy movement of the goods across the country.

In the manufacturing sector, we also took some private limited companies not listed in the stock exchange (hence they asked us not to make their individual company figures public). They are from such sub-sectors as cigarettes, garments (Surya Nepal), paints (Asian Paints), beer and instant noodles. Their figures confirm the conclusion made above that in case of companies operated by multinationals (directly or through technical-managerial collaboration), the sales have increased and so have the profitability, while in case of companies owned and operated by Nepalis alone, the sales are either flat or declining. This calls for a drastic change in the management of these Nepali-managed units—at least in the mindset of those who control the management in these units. In fact it is not simply the foreign collaboration that makes the companies good performers, rather it is the good corporate/managerial culture followed in them that does the trick. The foreign connection has provided the environment for such culture to flourish.

A remarkable improvement in the performance is reported by the power sector. It is noteworthy in the view of the fact that the state controlled Nepal Electricity Authority (NEA) is complaining of heavy losses. However, NEA states in its unaudited report for 2003-04 that its sales (both in monetary and quantitative terms) have increased by about 7%. Though it reported net loss in the year, the amount of the loss has gone down. While it shows the possibility of improving efficiency in public enterprises, the rigid systems in such enterprises existing because of government control are putting hurdles in achieving efficiency improvement.

The performance of Butwal Power, the only hydroelectricity company of which the audited annual report was available for analysis, is also remarkable because the area where it is generating and distribution power falls in the region which is regarded to be the hotbed of insurgency. The low performance of this company in the base year 2002-03 was mostly due to the damage caused by the insurgency to its power generation and distribution facility. Since the ongoing year is facing power shortage because of maintenance problem in NEA operated Kali Gandaki A power generation plant (the largest power plant of the country with an installed capacity of 144 MW), Butwal Power can be expected to generate more revenue and profit this year. This also indicates that the Nepali private sector has matured enough to deserve the right to distribute electricity. Their competency will be further enhanced if they are granted further territories to distribute electricity, so that the wastage incurred due to the still persisting inefficiency of NEA can be reduced.

All the government-owned enterprises do not deserve criticism. In addition to partially government-controlled Salt Trading Corporation Ltd., the 100% government-owned unit Nepal Telecommunication Company, gives an example of quite satisfactory performance. Though it is still not able to fulfil the entire demand for telephone services, it is reporting profits continuously and expanding its services from its own internally generated resources. However, the government’s recent decision to take nearly 1.4 billion rupees as dividend from this company has considerably sapped its resources now. So, it may not be able to carry on with its expansion plans in the current and forthcoming years. But as its annual report was not available, we could not present definite figures about the performance record of this company.

No matter how one may enjoy bashing the banks for their style of dealing with the borrowers, they provide one example of the best corporate practice. They are perhaps the most transparent business organisations in the country and publish the performance reports at least three times a year. Though, unfortunately, the figures presented in the non-audited financial reports of many banks are found to be a lot different from the ones presented in the audited reports, and thus the central bank needs to check this practice, these non-audited financial reports from the banks have been helping the stakeholders to a large extent, notwithstanding the differences in the figures when audited reports are brought out. The authorities should consider making public such quarterly or half-yearly reports compulsory also for other category companies.

While this helps the ordinary investors to make better informed decision while buying or selling the shares of these companies in the open market, the analysts, researchers and other decision makers will also benefit by a quick availability of authoritative information.

Though the above analysis shows that Nepal Inc. was performing well also during the period of bad law and order situation, it does not mean that law and order is not important for business. Nepal Inc. could have done lot better than what it did, had there been peace and better security.