Financial Analysis of Novatex

a. How has the customer performed relative to managements internal forecast

and industry? Comment on significant changes since prior year and versus
forecast. Identify key cash flow drivers (4-5, e.g. sales (driven by price/volume),
inventory (take into account obsolescence, build-up, seasonality), receivables
(evaluate realizability/quality, aging, concentration, inter-company financing),
payables (consider level of supplier financing, tenor, type) CAPEX requirements,
CMLTD. Use the operating results, cash generation, liquidity, solvency, and
capital structure as a guideline. Also, comment on the Contingent Liabilities,
if any, appearing in the companys balance sheet.
Chartered Accountants Hyder Bhimji & Co have audited the FY15 accounts for the
year ended June 30, 2015 of the company NOVATEX LIMITED. They have expressed their
opinion with the best of their knowledge to accept the firms accounts as a true and fair
representation of its performance.
Sales & Profitability
During the period under review, the revenue position of the company has decreased
by 15.28% to PKR 2821Mn over the corresponding year mainly due to the downward
correction of prices across the petrochemicals chain. As these petrochemicals are used in
the production of Novatexs product, RET resin, it resulted in lower sale prices which
ultimately resulted in lower sales value. It also led to losses on inventory held by the
company where raw materials having much higher prices were used to produce goods
which were sold at lower prices resulting in reduced contribution margin.
As far as the profitability is concerned, the profit after income tax has merely
increased by 0.37% to PKR 548Mn over the corresponding year. Even though there was a
hike in minimum wages by 20% and the power cost escalated as the Government
increased GIDC charges resulting in higher manufacturing cost, the financial charges
declined by 40% this year compared to the corresponding year due to efficient working
capital management and early repayment of long term loans carrying high rates of
markup.
Receivables, Payables & Inventory
The cash cycle of Novatex have decreased from 62 days to 49 days over the
corresponding year. Usually such a decrease has a very positive impact on the financial
results of the company; however, in this case, there has just been a mere increase in
profitability. The main reason behind the decrease in cash cycle is the decrease in the
inventory carrying period from 84 days to 68 days in 2015. This makes sense as the sales
price during the year 2015 relatively decreased due to which demand rose and the company
was able to get rid of the stock relatively early than before, even though it incurred losses
during the process as the raw materials already in stock were purchased at a higher price.
As far as the receivable and payable days are concerned, they were more or less constant
during the year compared to last year.

Liquidity

The companys current ratio has merely decreased from 1.24x to 1.23x as current
liabilities declined by 23.6% while current assets declined by 24.3%.

Capital Structure and Long term Solvency:

Net-worth has declined by PKR 4420Mn over the corresponding year mainly due to a
decrease in Long term financing. Current liabilities have also declined by 23.6% to PKR
10872Mn. As far as the asset side is concerned, after accounting for depreciation of PKR
1029Mn for the year, there has been a slight decline in the value of fixed assets by 1.53% to
PKR 7906Mn. Investment in subsidiary companies like G-pac corporation and Krystopac
Energy, and associated company by the name of Bangladesh Polymers Limited has
increased by 21.3% to PKR 182Mn. The firm holds 42.35% shareholding of the associated
company. Also, interest coverage ratio considerably improved from 0.6x to 1.05x which
represents efficiency on part of the company to pay its interest expenses.

Cash Flows:
Net cash from operating activities has dramatically improved to PKR 4335Mn in FY15
compared to PKR 1608Mn last year. This is majorly due to a decrease in stock in trade by
PKR 2292Mn over the corresponding year.

b. Comment on expected financial results during the currency of our facilities.

State and provide rationale for key assumptions that impact key cash flow
drivers (include comment on withdrawals and dividend policy) for likely and
downside scenarios. Focus on repayment capacity for all obligations. Relate
results with covenants. Please also note that the financial projections must be
generated for the period equivalent to the tenor of facilities proposed or
generally for a minimum of three years.
Novatex is a leading name in manufacturing RET Resin Bottle Grade. In FY15, the
company has clocked a substantial PKR 6.3Bn decline in sales to reach net sales of PKR
34783Mn for the year. However, the GP margin improved to 8.1% from 7.7% over the
corresponding year because the COGS did not decrease by the same proportion as the net
decrease in sales. Administration, distributive, selling and other operating expenses have
overall decreased in totality by 1.73% while the financial charges have also declined
substantially by 40% during the period under review. The operating margin has been more
or less constant over the year (3%) as the decrease in operating expenses were
compensated by a decrease in other income this year compared to last year. The company
has a pre-tax profit of PKR 548Mn (4.37% higher than last year) courtesy a decrease in
finance cost of PKR 346Mn compared to last year.

Short term borrowing has decreased by 24% over the corresponding year. However,
the current ratio has merely declined from 1.24x to 1.23x majorly due to proportionate
decrease in current assets and current liabilities.

c. Comment on financial flexibility, objectives and strategy. Discuss adequacy of

capital and bank lines, given industry norms and operating cycle. How sensitive
are the total facilities to external factors? Highlight any instances/prospects of
inter-company financing and its implications. Comment on the customers
access to alternate financing sources.

The company has a strong reputation in the market as it has been in the
production of PET Resin since 1998. It is the only manufacturer of PET Resin in Pakistan
and so has developed a monopoly in the market. It has Investments in subsidiary
companies like G-pac Corporation and Krystopac Energy, and associated company by the
name of Bangladesh Polymers Limited. It is also maintaining relationships with 15 banks in
Pakistan from all tiers. These facts suggest that it possesses strong financial flexibility.
It is pertinent to mention that the company incurred losses of its inventory due to
the downward correction of prices across the petrochemical chain. However, because of
the companys high capability, monopolistic power, and recent CAPEX to increase annual
capacity, it has what it takes to be best in the market and experience high growth levels.

d. Is the customer sensitive to risks emanating from financing strategy (interest

rate, liquidity) and operating flows? Is the financing and hedging strategy
appropriate for the business and level of sophistication? Why? Comment on FX
and interest rate exposures.
The companys risk management activities are well integrated with strategic
planning, ensuring that risk mindsets and strategy are compatible with each other. It
ensures insurance of physical assets against unforeseen events.
The Company directly competes with foreign/producers and so is exposed to
exchange rate movements. PKR is on a rise this year against the dollar with the FX rate of
105.4.To mitigate the FX risk, it usually enters into forward export contracts. As far as
imports are concerned, the potential increased cost due to FX risk is transferred to
customers to maintain margins.