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Strategic management report engro polymer and chemicals limited

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  • 1. Engro Polymer and Chemicals Limited Table of Contents1.0 History and Overview…………………………………………………………………………………………………………………………31.1 Mission Statement .................................................................................................................................. 41.2 Core Values ............................................................................................................................................. 41.3 Products .................................................................................................................................................. 51.4 Major Customers .................................................................................................................................... 51.4 Exports .................................................................................................................................................... 61.5 Economic Performance .......................................................................................................................... 62.1 Political .................................................................................................................................................... 72.2 Economic ................................................................................................................................................. 72.3 Social ....................................................................................................................................................... 82.4 Technological .......................................................................................................................................... 82.5 Environmental ......................................................................................................................................... 83.1 Strengths ................................................................................................................................................. 93.2 Weaknesses ............................................................................................................................................ 93.3 Opportunities ........................................................................................................................................ 103.4 Threats: ................................................................................................................................................. 105.1 SPACE MATRIX – Diagram ..................................................................................................................... 145.2 ANALYSIS ............................................................................................................................................... 146.1 Financial Situation ................................................................................................................................. 156.2 Marketing .............................................................................................................................................. 17 6.2.1 Customer Focus.............................................................................................................................. 17 6.2.2 Market Development ..................................................................................................................... 18 6.2.3 Horizontal Expansion and Vertical Integration .............................................................................. 18 6.2.4 Related Diversification ................................................................................................................... 19 6.2.5 Corporate Social Responsibility ..................................................................................................... 19 6.2.6 Research and Development ........................................................................................................... 19 6.2.7 Competitive Advantage ................................................................................................................. 206.3 Human Resource and Administration ................................................................................................... 207.1 Problems related to Forecasting and Inexperience .............................................................................. 21 1
  • 2. Engro Polymer and Chemicals Limited7.2 Problems related to financial and debt management .......................................................................... 227.3 Management Issues .............................................................................................................................. 238.1 EDC-VCM Plant Action .......................................................................................................................... 248.2 Debt Management ................................................................................................................................ 258.3 Export Plan ............................................................................................................................................ 258.4 Back-up and Forecasting Plan ............................................................................................................... 258.5 Product and Market Development ....................................................................................................... 269.0 Conclusion……………………………………………………………………………………………………………………………………….279.1 Future Financial Outlook ....................................................................................................................... 27 2
  • 3. Engro Polymer and Chemicals Limited1.0 History & OverviewEngro Polymer & Chemicals Limited previously Engro Asahi Polymer & Chemical Limited is oneof the subsidiaries of Engro Corporation, the leading Pakistani business conglomerates withstakes in the fertilizer, food, petrochemicals, power generation, automation and terminal storageindustries. Engro Group consists of following subsidiaries:Engro Asahi Polymer & Chemicals Limited was a joint venture between Engro ChemicalPakistan Ltd. (ECPL), Asahi Glass Company and Mitsubishi Corporation (Japan), each with a50%, 30% and 20% shareholding, respectively. Later, Asahi Glass Company decided to moveout of Poly Vinyl Chloride (PVC) and Vinyl Chloride Monomer (VCM) business worldwide andoffered to sell its holding. Engro Chemicals bought the entire shareholding of Asahi GlassCompany and increased its share to 80%.In June 2008, EPCL went public by offering 50 million shares and received the amount of Rs.2.8 billion against the offered amount of Rs. 900 million. After the initial public offer Engro‟sshare in EPCL remained to 56%. Other shareholders included IFC (15%), Mitsubishi (11%),Individuals (9%) and others (9%). 3
  • 4. Engro Polymer and Chemicals LimitedEPCL started as the only PVC manufacturer in Pakistan with a capacity of 100,000 tons perannum and its operations are located at Port Qasim in Karachi. Its plant was commissioned inNovember 14, 1999 and IFC assisted in the financing of this plant. In 2009, EPCL madeexpansion in the plant horizontally and vertically by installing 50,000 tons more PVC resinfacility and a facility to manufacture Ethylene di Chloride (EDC) and Vinyl Chloride Monomer(VCM), which are the basic raw material and PVC resin manufacturing. In order to diversify thebusiness and lessen its dependence on the PVC resin business, EPCL also installed Caustic Sodaplant with a capacity of 105,000 tons. Now EPCL has a capacity of producing 150,000 tons ofPVC, 240,000 tons of EDC, 216,000 tons of VCM and 105,000 tons of Caustic Soda, annually.1.1 Mission Statement Our mission is to achieve innovative growth which creates value for our stakeholders, customers and employees. Our commitment is to maintain higher standards of ethics, safety and environmental responsibility1.2 Core Values 4
  • 5. Engro Polymer and Chemicals Limited1.3 ProductsBeing the sole manufacturer of PVC resin in the country, EPCL‟s PVC resin sold under thebrand name of SABZ dominates the domestic market. SABZ is available in 5 variationslisted below, SABZ PVC AU-58 SABZ PVC AU-60 SABZ PVC AU-67S SABZ PVC AU-67R SABX PVC AU-72The above listed products differ in their molecular weight and are used according to application.SABZ PVC AU-72 is a high molecular weight suspension resin, therefore, it is used as a rawmaterial in the production of electrically insulated PVC cables. Whereas, SABS AU-60 is amedium-low molecular weight suspension resin and is used as raw material in the rigid PVCapplication.EPCL also started the production of Caustic Soda and sells it to textile mills, leather mills andsoaps and detergent manufacturers.The Company is also expanding its warehousing network to ensure that PVC stock isreadily available in various key cities of the country. EPCL currently has six warehouses infive cities namely, Karachi, Lahore, Multan, Faisalabad Islamabad and Quetta.1.4 Major CustomersThe customer base of the Company comprises of all categories of PVC application manufacturers.The largest domestic consumer is the Pipe Sector. This sector is showing strong growth on aconsistent basis. This is because the PVC pipes are now increasingly used in housing andconstruction, water supply and sewerage, telecommunications and agriculture. The Company‟sother customers include manufacturers of artificial leather, shoes, garden hoses, cable compounds,films, rigid sheets, etc. 5
  • 6. Engro Polymer and Chemicals Limited1.4 ExportsThe Company has established itself as a regular supplier to several businesses in the regionthus establishing a strong customer base outside Pakistan. The international customer base islocated in Sri Lanka, Bangladesh, UAE, Bahrain, etc. High Product quality with its strategicgeographical location has given the company an advantage to successfully provide a level ofexports at a competitive price.1.5 Economic PerformanceEPCL has maintained a steady pace of business development through complete business reviews,risk management, technical services, impact of back integration project, customer services,sales/market share, financial risk management, financial review etc to estimate the companyseconomic performance.EPCL plays an important part in the development of national economy with a strong sense ofresponsibility for their people by protecting and preserving their interests, hence growing profits. 6
  • 7. Engro Polymer and Chemicals Limited2.0 PESTE ANALYSIS2.1 PoliticalDifferent rules and regulations do exist that companies dealing with chemicals have to follow.There have been situations in the past, where EPCL and Government of Pakistan have some taxissues to settle. Still, in 2010 there are pending tax rebates, for which EPCL had also filedrequests to the taxation department. Due to the lag in solving the issue by the income taxdepartment and excise duty department EPCL has also filed cases in Sindh High Court and evenSupreme Court. The payment of Rs. 84 million is still pendingThe geo-political situation and frequent instances of unrest are also affecting the operations ofthe company. This is in the form of delay in procurement of raw materials and distribution oftheir products to the market. Therefore, in order to resolve the delayed procurements issues,EPCL has installed tracking devices in all of its Caustic Soda transportation vehicles in order tokeep track of he product delivery process and to keep the customers updated with the productdelivery process.Being a player in the chemical industry, EPCL could have aced opposition from theenvironmental agencies, but EPCL is very transparent in environmental reporting as it isfollowing the maximum environment friendly standards in production. Last year, ACCA-WWFan international environment agency awarded Pakistan Environmental Reporting Award toEPCL for its transparent reporting and environment friendly standards.2.2 EconomicThe economic situation in the country also indirectly affects the business of EPCL. This isbecause the demand of the major products of the company, like PVC, is majorly related to therise and fall of the construction industry. And, the amount of construction taking place dependson the earning of the population, the economic situation of the government, investment anddevelopmental projects in the country. This is because the products that are made out of PVC aremainly used by the construction industry, like pipes, door and window frames, etc. So, if there isa lot of construction going on, demand for ECPL products will also be on a rise and vice versa. 7
  • 8. Engro Polymer and Chemicals LimitedThe demand for PVC was expected to grow at the rate of 14% every year in domestic market dueto low per capita PVC consumption and increased infrastructure development. But, unfortunatefloods on 2010 had severely affected the demand for PVC in the domestic market. The PVCdemand in Pakistan is again expected to rise in 2H2011, due to full swing in flood reliefoperations.2.3 SocialThe social factor affects EPCL in a way that the international economy has just shown somesigns of economic recovery, whereas, Pakistan is still passing through tough liquidity crunch andfinancial crisis due to the recent floods. Therefore, the social behavior of the population of thecountry has now strongly shifted from that of the spenders to the savers, which has also affectedthe demand for PVC in the domestic market. Moreover, the current uncertainty and law ordersituation in the country has also contributed in shifting the social behavior of the population fromactive spenders to passive spenders.2.4 TechnologicalTechnology plays an important part in any industry. Every now and then, breakthroughs in theworld of technology are happening and constant evolution is taking place. Being a manufacturingcompany EPCL works with different machines, equipments and even processes which are a partof technology. EPCL will have to keep itself updated with the latest PVC manufacturingtechnology to avoid any technology obsolescence risk. EPCL is producing PVC with the rawmaterial known as VCM which is the common international technology; the other traditionalmethod was the production of PVC resin through calcium carbide. EPCL has to keep keep trackof the PVC manufacturing technology to prevent itself from operating on less efficienttechnologies.2.5 EnvironmentalAlmost all chemical manufacturing plants release different kinds of gases and produce solid andhazardous waste, such as sanitary waste, that cause environmental pollution and even healthhazards. ECPL shows strong conviction in keeping itself environment friendly by adoptingvarious international standards and internally built Environment Management System – EMS.The company is also ISO 14001:2004 certified and is being regularly audited for environmental 8
  • 9. Engro Polymer and Chemicals Limitedcompliance. To make its expansion project extremely environment friendly, it envisages state ofthe art environment initiatives like waste handling, liquid waste disposal, new waste watertreatment unit and on site Evaporation plant for treating waste.3.0 SWOT3.1 Strengths The parent brand name of Engro Group lends the market an financial strength to all its subsidiaries including Engro Polymer and Chemicals Limited. EPCL is the sole producer and marketer of PVC (Poly Vinyl Chloride) resin in the market, thus operating as a monopoly. It covers 70%-80% of the total market for PVC resin. Chlorine, Ethylene di Chloride and Vinyl Chloride Monomer manufacturing facilities which are the basic raw material in the production of Poly Vinyl Chloride. These raw material facilities are achieved through backward integration plan of EPCL. Loyal customer base that has been established through years of strategic long term relationship building.. High entry barriers in the PVC manufacturing market also serve as one of the major strengths of EPCL. These high entry barriers have been achieved through continuous investment in processes thus reducing the cost of producing PVC through backward integration.3.2 Weaknesses EPCL has a weak management, proven by inefficient forecasting, inability to plan for unforeseen incidents, delays in decisions etc. EPCL has been facing operational constraints due to the maintenance needs of the used VCM plant EPCL bought in 2008. Weak interest coverage and quick ratio adds to liquidity crunch that EPCL is going through, due to which it is breaching its debt obligations. 9
  • 10. Engro Polymer and Chemicals Limited3.3 Opportunities EPCL can further increase its production capacity of PVC from 150,000 tons as in Pakistan the demand for PVC is going to increase in future due to extremely low per capita PVC consumption as compared to the region. Pakistan has per capita PVC consumption of 0.7 kg where as China, India and Thailand has per capita PVC consumption of 7.5 kg, 1.2 kg and 8.5 kg respectively. International demand for PVC is very high, so EPCL can expand its markets internationally especially to India, China and Indonesia where are per capita PVC consumption is expected to grow in near future due to the extent of infrastructure development going in these countries. Infrastructure development in the flood affected areas also serve as an opportunity for EPCL as PVC pipes, windows, doors and other material will be required in huge quantities. Drip irrigation system is a huge opportunity for EPCL as smart use of water is being promoted by Govt. of Pakistan and the awareness of technologically advance irrigation system is increasing in domestic markets. This drip irrigation system includes PVC pipes as a major part of the system thus directly increasing the demand for PVC pipes and indirectly increasing the demand for PVC resin.3.4 Threats: Ethylene prices in the international market posses itself as major threat to EPCL. After the installation of the production facility of EDC and VCM, ethylene remains as major raw material that EPCL has to purchase in order to manufacture PVC. Thus, earning per share is highly sensitive to the ethylene prices in the international market. 10
  • 11. Engro Polymer and Chemicals LimitedFuture economic downturn may result in lower demand of PVC resin by the industriesuse PVC as a raw material.High depreciation and interest charges due to recent facility expansion also serve as amajor threat to EPCL. In case of any further breakdowns on the plant EPCL can haveirreversible damages to the balance sheet and income statement.Due to the lack of experience of operating EDC and VCM plants, EPCL had a fireincident in December 2009 which had a very negative impact on the already sensitivecurrent and interest coverage ratio and the bottom line. The in experience can furtherhamper operations and maintainenece of EDC and VCM plants.Geo-political situation in Pakistan serves as major threat to the timely distribution of theraw material to EPCL and manufactured PVC resin to customers.PVC manufacturing technology with EPCL can become obsolete in the near future. 11
  • 12. Engro Polymer and Chemicals Limited4.0 TOWS Matrix Strengths: Weaknesses: 1. Strong branding of Engro 1. Weak management Group 2. Operational constraints due 2. Sole producer of PVC to maintenance needs in Pakistan 3. Weak interest coverage and 3. Backward integration for quick ratio- debt obligations raw materials breached 4. Loyal customer base 5. High entry barriersOpportunities SO Strategies WO strategies1. Increase production S2O3O4: If demand of PVC W2O1: If the company cancapacity products increase in the overcome its current2. Expand in international market then this will be totally operational constraints ,markets beneficial for ECPL as they production capacity can be3. Infrastructure development are the sole PVC increased more effectivelyin flood affected areas-rise in manufacturers in the marketPVC demand S3O2: Other than4. Increased demand of internationally selling its mainadvanced irrigation system- products like PVC, the rawincrease in PVC demand materials being manufactured in-house can also be sold internationallyThreats ST strategies WT strategies1. Ethylene(raw material)price increase S3T1: Already being into W1T2T3T4: By strengthening2. Economic downturn backward integration, the its management, EPCL candecrease demand of PVC company can also consider in- avoid some threats. They will3. Breakdowns and other house production of Ethylene be better able to forecastincidents in the plant demand situations and thus4. In-experience in handling S1T4: The strong brand name make decisions aboutplants of VCM and EDC of Engro can help to attract overcoming related problems.5. Geo-political situation managerial and technical Similarly, having a better HRhampering supply and talent from the market could have saved them form adistribution number of operational6. Technology used becoming problems caused by notobsolete having professionals or technical people right at the start. 12
  • 13. Engro Polymer and Chemicals Limited5.0 Space Matrix S.No: Particulars Ratings Financial Strength (FS) 1. Profitability +3 2. Revenues +4 Sub Total +7 Industry Strength (IS) 1. Growth potential +4 2. Profit potential +4 3. Ease of entry into the market +2 4. Capacity utilization/productivity +3 Sub Total +13 Environmental Stability(ES) 1. Rate of inflation -4 2. Demand variability -4 3. Competitive pressures -2 4. Ease of exit from the market -5 Sub Total -15 Competitive Advantage 1. Market share -1 2. Product quality -2 3. Customer loyalty -3 4. Control over suppliers and distributors -4 Sub Total -10 Conclusion: ES Average is -15/4= -3.75, IS Average is +13/4= +3.25 CA Average is -10/4= -2.5 , FS Average is +7/2= +3.5 Directional Vector coordinates: x-axis: IS+CA= +3.25+ (-2.5)= +0.75 y-axis: FS+ES= +3.5 + (-3.75)= +0.25Scale-CA and ES values can range from -1 to -6 (-1 being best and -6 being worst)-IS and FS values can range from +1 to +6 (+1 being worst and +6 being best) 13
  • 14. Engro Polymer and Chemicals Limited 5.1 SPACE MATRIX – Diagram FS Conservative A Aggressive (0.25, 0.75)CA IS Defensive Competitive ES 5.2 ANALYSIS The space shows that ECPL has the internal strengths and competitive advantage to pursue aggressive strategies. The company has a strong brand name and a monopolistic characteristic because of which they can reap the benefits of opportunities available to them. They can go for strategies such as expansion, market development and market penetration using their strengths and competitive advantage. 14
  • 15. Engro Polymer and Chemicals Limited6.0 Current SituationEngro Polymer and Chemical-EPCL limited being the sole manufacturer and producer of Poly-Vinyl Chloride enjoys the monopoly in PVC market. EPCL is a subsidiary of Engro Corporationwhich owns majority of the share in the organization. Engro Corporation is the second largestproducer of urea in Pakistan with other subsidiaries including Engro Foods Limited, EngroEnergy Limited, Engro Avanceon, Engro Vopak Terminal Limited.EPCL‟s current situation in this case study has been reported with respect to the four key areas ofthe organization which include Finance, Marketing, Administration and Human Resource.6.1 Financial SituationOn the financial front, EPCL is in red since 2009 and has reported a heavy loss of Rs. 790mn in3Q2010 with a projected loss of around Rs. 926mn for the year 2010 against Rs. 232mn loss inyear 2009 and handsome Rs. 353mn after tax profit in 2008. These heavy losses in 2009 and2010 are mainly attributed to the backward integration and horizontal expansion of the facility atPort Qasim during 2009, where Engro invested $250mn a 236% non-current asset growth over2008 and 393% non-current liabilities growth over 2008. In-addition the financing costs,operating costs and rise in fuel prices also contributed to the losses reported in 2009 and 2010.The company after expanding the plant has a capacity of producing 150,000 metric tons of PVCas compared to 100,000 metric tons previously, reporting an increase of 50% to capture theprojected growth in the PVC market. In addition to this horizontal expansion, EPCL alsointegrated backwardly to produce the basic raw materials for PVC that were Vinyl ChlorideMonomer-VCM (capacity of 204,000 tons), Ethylene Di Chloride-EDC (capacity of 230,000tons) and Chlorine (capacity of 94,200 tons) to lower the cost of raw material and improve theprofitability. A plant to produce Caustic Soda (capacity of 105,000 tons) was also installed toimprove the product offering of EPCL.These expansions also brought some difficult times for EPCL when a fire incident was reportedin December 2009 where all the plants had to be shutdown. Plants PVC, EDC and Caustic Sodawere re-opened later in the same month with minor maintainenece but VCM plant remained un-operational till April of 2010 due to which the plant could not commercial operational status till 15
  • 16. Engro Polymer and Chemicals Limitedthe September of 2010. This incident also contributed to the heavy losses in 2010 as the plantremained un-operational but the depreciation costs, financing costs and operational cash chargeswere levied in the balance sheets and income statements plus the high cost of importing VCMwas being incurred by EPCL despite of having the facility. VCM prices rose from USD 880 toUSD 985 in just the 3rd quarter of 2010.EPCL has net revenue of around Rs. 10.5bn in first 9 months of 2010 with a growth of 28% if wecompare it to the same 9 months period of 2009. EPCL had recorded net revenue of Rs. 11bn in2009 which was the highest since its inception and EPCL is expected to cross that mark this yearwith just Rs. 0.5bn away in just first 9 months of 2010. Unfortunately, these high revenues arenot affecting the bottom line of the company as COGS also increased 34% in 9M2010particularly because of the non-availability of the in-house VCM plus high fuel, operations andfinancing cost which grew by shocking 197% in 9M2010 over the period of 9M2009.EPCL‟s gross margin has been decreasing ever since 2006 and is down to the level of 6.05% in9M2010 from the highest in the company history, 19.40% in 2006. Which means that thecompany‟s COGS has been increasing since 2006 and EPCL is unable to control it despite itseffort to produce VCM in-house. The gross margin is expected to rise once the VCM plant is100% operational and produces enough VCM to satisfy the demand of EPCL‟s PVC plant. ButEthylene and fuel price increases in the international market remains a concern for EPCL.The net profit margin of EPCL is also showing alarming result for EPCL as in 9M2010 the netprofit margin has shown a negative growth of 7.52% as compared to 0.26% negative growth in 16
  • 17. Engro Polymer and Chemicals Limited9M2009. This negative growth is attributed to the above mentioned COGS, operating andfinancing costs. The outlook for the 4Q2010 also looks grim and EPCL is expected to file a lossRs. 926mn which is further expected to show a negative growth due to low demand of PVC indomestic market.The current and quick ratios of EPCL are also decreasing ever since the expansion. Current andquick ratios currently are at the level of 0.66 and 0.32 in 9M2010 dropped down from the levelof 3.62 and 2.84 in 2007. This shows an alarming situation for the EPCL and it is facingchallenges in honoring the short-term and long term debts to the extent that, it remains in breachof the loan payment agreement.Another alarming sign for EPCL is the Interest coverage ratio which has decreased to the extentthat it is in negative, -0.23 in 9M2010. The interest coverage was at the level of 25.32 in 2008which has been drastically decreased due to heavy expansion financing.The return on stakeholder‟s equity is also on a strong negative trend with return falling frompositive 18.63% in 2006, negative 3.65% in year 2009 to negative 11.49% in 9M2010. Inaddition EPCL also announced Rs. 1.28 loss per share in 9M2010 as compared to Rs. 0.04 lossper share in 9M2009 and Rs. 0.45 loss per share in 2009. It is projected that the EPCL‟s loss pershare for 2010 will be Rs. 1.46.6.2 MarketingEngro Polymer and Chemical Limited being the only supplier of PVC in Pakistan enjoys thecomplete market share of PVC but unlike other monopolistic organizations and businesses indifferent industries values its customers a lot. In fact, the core values pyramid of Engro Polymerdescribes “Customer Focus” as one of the core value of EPCL, which states that, customer needsare their primary focus as they define the reason of EPCL‟s existence.6.2.1 Customer FocusEPCL is the organization of its words; it has actually worked mutually with its clients to helpthem grow their business. Help is in terms of both managerial and technical support. EPCL hasmore than 400 small and big customers and according to CEO, Mr. Qadir, there is not a singecustomer out of these 400 customers that has not been visited by the professionals of EngroPolymer. 17
  • 18. Engro Polymer and Chemicals LimitedEngro Polymer has directly helped PVC pipe industries in growing their businesses and in resulttheir capacity has doubled over the period of five years. In addition, 10 years ago, the industrycould only manufacture PVC pipes with only 4 inches diameter but now, they can manufacturePVC pipes with 20 inches in diameter with additional uses. Moreover, EPCL also technicallysupported dying cable compounding industry in a way that previously the industry used to import10,000 tons of cable compound but now it is manufacturing 8,000 tons of it.EPCL specializes in customer focus to the extent that they also work to help customers ofcustomers. Drip Irrigation System is that sophisticated technology that helps farmers inpreserving water while increasing their agricultural output. This technology promotes the use ofPVC pipes which ultimately helps PVC pipe manufacturers and their consumers in conservingwater.EPCL, in addition to the above taken steps also helps in developing the customer human resourcethrough proper trainings and guidance. With this 16 Customer Technical Audits were alsoconducted in order to help improve its customers production processes, recipes, quality of theproduct and output of the factory. EPCL has also equipped all of its vehicles of Caustic Soda unitwith trackers to ensure timely delivery of the raw material to the customer.6.2.2 Market DevelopmentIn order to target handsome growth rate in revenues and profitabity and to lower its dependenceon domestic market Engro is also exporting excess of PVC to international customers in SriLanka, Bangladesh, UAE and Bahrain. However the exports are limited due to the huge demandof PVC in domestic market.6.2.3 Horizontal Expansion and Vertical IntegrationEPCL in order to meet the growing demand of PVC in the Domestic and International Marketgrew horizontally with an addition of 50,000 KTons PVC manufacturing capacity. This additionhas increased PVC production EPCL by 50% to 150,000 KTons. Plus it also integrated itself inbackward direction with the installation of the raw basic raw materials manufacturing capacities.The new plants enable EPCL to manufacture Chlorine, Ethylene di-chloride - EDC and VinylChloride Monomer – VCM, which are the basic raw material in PVC production. This backwardintegration helped EPCL in lowering its dependence on imported VCM which incurred highercost and risks due to international market and exchange rates 18
  • 19. Engro Polymer and Chemicals LimitedHowever, this expansion and integration could not help EPCL in 2010, as due to unfortunate fireincidence at the factory in December 2009, VCM plant suffered damages and could not be put oncommercial production status until September, 2010. Delay in the VCM plant start-up caused in-house VCM shortages which also effected the PVC production as VCM was also short ininternational. This long delay also contributed primarily in filling huge losses in the incomestatements of EPCL in first three quarters of 2010 with total expected loss of Rs. 1014 million in2010.6.2.4 Related DiversificationEPCL has also diversified in a related business with the production of Caustic Soda. The demandof Caustic Soda is around 230,000 tons in domestic market and EPCL with its caustic soda planthas a capacity to manufacture 105,000 tons with major customer being textile industries andsoaps and detergents factories. The Caustic Soda market is growing in Pakistan and EPCL inorder to not to solely base its revenue chain on PVC has expanded into Caustic Soda market.6.2.5 Corporate Social ResponsibilityCorporate Social Responsibility is also one of the key concern areas for Engro Polymer as itinvests huge amount in building a safer, healthier and a prosperous community. EPCL spent Rs.8.4 million in 2009 in different projects. Projects include, 100 hectares of plantation projects tocontribute towards greener Pakistan, clear drinking water project was installed by EPCL inRazzakabad and Ghangar Phatak, Earth day celebration with the local community and variousEducation projects including, Support Community Schools, EPCL Scholarship Programs,Taleemi Mela Sponserships and Donations.6.2.6 Research and DevelopmentEPCL also ensures that it conducts proper research and development in order to continuouslyimprove its products, facilities and processes. In an effort to modernize its products, EPCL localresearchers developed lead free pipes for use in portable water systems, food grade geomembrane for lining water reservoirs, medical compounds or I.V sets and syringe gaskets.Furthermore, EPCL is also studying the methods to utilize the Hydrogen which is available atsite and ways to grow PVC and Caustic Soda capacity. 19
  • 20. Engro Polymer and Chemicals Limited6.2.7 Competitive AdvantageCompetitive advantage to Engro Polymer is its position as a sole manufacturer of PVC in thePakistani market. Engro Polymer enjoys the complete market share of Pakistan‟s PVC marketwith less than 5,000 tons of PVC resin imports by small traders. EPCL has a very strongadvantage over traders who incur high duties, freight charges, financing costs and warehousingcharges while importing PVC resin.This cost advantage will sustained by Engro Polymer in long term in way that it has nowinstalled EDC and VCM plant which are the basic raw materials of PVC, thus reducing costs,increasing entry barriers and weakening importers further.In addition, the long-term customer relationship management of EPCL has also developed as oneits key strengths in the market. The infrastructure and value addition facilities that EPCL has arevery difficult to imitate, thus making sure that the competitive advantage is for long-term andsustainable.6.3 Human Resource and AdministrationEngro Polymer believes that the success of the organization is highly dependent on the skills ofits workforce. EPCL specially focuses on the development of the employee so that he/she canbetter handle professional challenges. According to the figures of 2009, EPCL has 350employees, which has doubled from 2007 due to expansion/integration plan. At Engro Polymerthe rights of the employees are respected and the organization promotes freedom of opinion,expression and open dialogue policy.EPCL offers market competitive compensations and awards incentives on the employee‟s levelof performance which automatically triggers an enthusiasm to excel. Incentive like EmployShare Scheme has also been introduced at Engro to reward employees and to build a sense ofownership in them. This policy of EPCL makes sure that the employees grow as the organizationgrows. EPCL also puts especial emphasis on the regular training and skill development of itsemployees. For this, various training on different subjects like management, plant operations andmaintainenece, IT, marketing and finance are conducted. In 2009, EPCL invested around Rs. 54million on trainings and travelling. 20
  • 21. Engro Polymer and Chemicals LimitedDespite the above measures, technical human resource planning has served as a major flaw forthe organization. After the expansion and integration, EPCL faced lack of VCM plant operationsmaintainenece specialties in its existing human resource. Due to the lack of operations andmaintenance skills, EPCL incurred huge losses in terms of VCM plant catching fire and delayedre-startup of the plant. EPCL after facing the losses has hired international expertise in operatingand maintaining the VCM plant. Had it been done before, EPCL might not have faced the fireincident and ultimately huge losses and delayed re-start-ups.Plus, covering more of the administrative side of the Engro Polymer, there still are many gaps inthe productions processes. VCM plant re-start-up was unnecessarily delayed due to lack ofplanning of maintenance schedules, moreover, when there was a shortage of in-house VCM inlast half of 2009 and first half of 2010, there was no future risk, back-up and alternate supplierplanning due to which EPCL had to limit PVC to plant to the capacity of 116,000 tons withmaximum capacity of 150,000 tons.7.0 Problems AnalysesEngro Polymer, being in losses for a couple of years, has problems mostly related toinexperience in managing backward integration, forecasting, financial management and some ofmanagement issues. The losses are the result of some inappropriate and late decision making bythe organization. We will discuss each of problems under each category.7.1 Problems related to Forecasting and InexperienceEngro Polymer is the largest and the only PVC producer in Pakistan. From 2008 however, someof the major changes in the production occurred. Company‟s PVC production was decreased dueto shortage of the imported raw material that is VCM. The company did anticipate the shortageearlier as well and decided to set up another VCM production plant in the country. This newplant was needed to manage the shortfall and the plant was expected to operate by 2009. Thiswas good backward integration decision as it would have drastically reduced the raw materialimport cost of EPCL due to in-house VCM and EDC manufacturing facilities. But due toinefficient prediction and forecasting of shortfall, the shortage started to occur before the plant‟soperations could begin. The company then decided to purchase VCM from international market 21
  • 22. Engro Polymer and Chemicals Limitedon spot basis. The raw material in international market was on peak prices and therefore it addedto the costs of Engro Polymer. In addition, the forecasting of future demand in 2008 and 2009 for2010 and onwards was unrealistic considering the financial crisis had just started at that time.EPCL should have taken a more realistic path towards forecasting future demand of PVC.Moreover, after the inauguration of the VCM plant, it caught fire in December of 2009 due tolack of expertise in managing the new VCM and EDC plants. If EPCL would have hiredexperienced professionals to manage new VCM and EDC plants, it would have been facingmuch lesser extent of financial problem than it is facing now.After the fire incident at VCM plant, EPCL suffered form extremely low level of in-house VCMproduction till September of 2010, which again forced them to import VCM from theinternational market on higher prices while incurring depreciation and interest charges on thenewly imported plant. VCM in the international market fell short in 2010 due to which the PVCplant operated on 71% efficiency in first 9 months of 2010. This phenomenon had a doublenegative impact on the income statement of EPCL while reporting a loss of Rs. 790 million in9M2010.7.2 Problems related to financial and debt managementApart from the above mentioned problem, another problem in Engro Polymer was seen as relatedto financial and debt management. Engro Polymer has been breaching few of loan agreementsand form past one year; the raw material costs have been drastically increased and the in-houseraw material production is on extremely low levels. Moreover, the investment for new VCMplant have also added to the debts. Engro‟s long term debt to equity ratio has increased by 67%from 0.21 in 2007 to 0.64 in 2009 and the interest coverage ratio has decreased by 94.3% from25.32 in 2008 to 1.44 in 2009, thereby adding to the poor financing and payback policies.Other reasons adding to the costs include incremental costs due to depreciation of assets,financial credit term agreements and increasing fixed costs due to expansion and backwardintegration.Analyzing the problem strategically, the financial analyses of the organization have not beencalculated properly, the company is relying on too much of debts from banking and otherentities. Common stocks have also been issued to the general public, to whom; Engro has failed 22
  • 23. Engro Polymer and Chemicals Limitedto give dividends for past couple of years. The debt ratio of the company is greater than theindustry average and the company is expected to be in loss at least till the end of year 2011 or1H2012.7.3 Management IssuesEngro Polymer is a result of acquisition of Esso (later renamed as Exxon) in 1991 and it is nowpart of Engro Group which has a diversified range of products from Fertilizers to foods. It isimportant to understand that the management of Exxon was taken over by the management ofEngro and therefore there was a shift in management style. The company‟s profitabilitycondition was very positive and the future was optimistic as well. However, Engro groupgradually started diversifying into other categories, especially Engro foods after which theexpansion was rapid, the financials were needed and company started relying too much on debtfinancing. In spite of the fact that Engro Polymer is a separated entity and operates irrespectiveof what the other entities in Engro group are up to, the link between the companies under thename of „Engro‟ cannot be broken. Therefore, when the fertilizer business, which is the cashcow, was doing excellent in the market, polymer business still had to rely on debt financing fromexternal sources, whereas the same cash could have been provided by fertilizers as credit onlower rates. Therefore the lack of coordination within the business under Engro Group isminimal.The management in Engro Polymer business has not been proactive enough to assess the marketsituation, the availability of VCM in local and international markets. The prediction was late andtherefore as a result, the new plant was not ready to operate while the local unavailability ofsufficient VCM was prevalent. This further resulted in reliance on external finances in order tomeet the demands, as a result, the cost of raw material increased and profits decreased to extentof transferring into losses. The company also breached some of the contracts and is expected todefault on few other payments by the end of the year due to late-commercialization of the VCMplant.The overall management decision regarding the most important factors like production facilityexpansion, financial and debt management pose a great threat to the organization in future. EngroPolymer has been on reactive approach rather than proactive one as the company was not able toanticipate the future problems and kept relying too much on debt. This may also be due to the 23
  • 24. Engro Polymer and Chemicals Limitedlack of competition, because of which the management has been complacent in taking suchdecisions. The overall growth of Engro Group has neglected some of the core businesses likeEngro polymer and therefore resulted in consistent losses.8.0 Future Proposed StrategyAfter the detailed and thorough analysis of Engro Polymer and Chemicals Limited, we haveprepared a strategy that will enable EPCL to come out of these difficult times successfully. Thestrategy is named as “The New-Fangled Approach”, which encompasses, EDC-VCM Plant Action Debt Management Export Plan Back-up and Forecasting Plan Product and Market Development8.1 EDC-VCM Plant ActionEPCL‟s VCM plant caught fire in December of 2009 due to lack of expertise and experience ofEPCL in managing the new facility. After the fire, VCM plant remained un-operational sinceApril 2010 and could not achieve the Commercial Operations status since September 2010 due towhich EPCL reported huge losses.This lack of expertise and experience in operating VCM plant was due to non-hiring of expertsfor the job. EPCL now should hire international experts for the job, so that future such incidentscan be minimized. EPCL with its international expertise should focus on the efficiency of theVCM plant as it affects the capacity of the PVC plant as well.Operating VCM plant at 100% efficiency would (1) reduce the raw material cost, (2) improve theefficiency of the PVC and (3) most importantly will play a major role in bringing EPCL out oflosses. 24
  • 25. Engro Polymer and Chemicals Limited8.2 Debt ManagementThere is a need to take EPCL out of losses through proper debt management. The debt on EPCLis accruing huge interest charges due to which EPCL is breaching many of its loan agreements.Debt refinancing is an attractive option for EPCL, where the debt refinancing should not be donethrough financing institutions but through Engro Corp. itself. Engro Corp. being the majorshareholder in EPCL should refinance it debt on lower interest rates with deferred payments.Term finance certificates like Engro Rupiah or sucking cash out of its cash cow like EngroFertilizer can provide the amount needed to refinance the debt on lower interest rates.This debt refinancing would immensely reduce the interest rate pressure on EPCL and wouldalso provide EPCL with cash to inline its operations once again.8.3 Export PlanAfter the recent economical situation and floods in Pakistan, the demand for PVC is not expectedto remain upbeat for the 4sth quarter and 1H2011. Therefore, EPCL can have excess of PVC in2011 which can be exported to earn more revenue. The more profitable export arenas for EPCLcan be China and India as their per capita PVC consumption is on low levels as compared toKorea per capita PVC consumption of around 20kg.Furthermore, as Caustic Soda demand in domesticmarket is 230-240k tons, EPCL‟s caustic sodaproduction will produce excess in the market andprices locally will fall further. Therefore, instead ofcompletely focusing on domestic market with causticsoda production, EPCL should equally focus onexporting caustic soda to India and China.8.4 Back-up and Forecasting PlanAfter the unfortunate fire incident at VCM plant and delay in commercial operations, EPCLfaced massive shortages of in-house VCM. This shortage forced EPCL to again start importingVCM until its plant gets operational. EPCL, then started importing VCM on higher prices due tointernational supply shortages and then had to stop PVC plant, courtesy further shortages in 25
  • 26. Engro Polymer and Chemicals Limitedinternational market. Due to this VCM supply and demand situation in international market,EPCL suffered with high cost of goods sold which increased by 55% from 2008 to 2009,whereas, gross profit only increased by 2% during the same period.EPCL, in order to prevent itself from such situations in the future should keep its VCM plantfunctional at100 efficiency, through proper maintenance, operations and management skills andexpertise, as it is a basic raw material in PVC production. Moreover, if the VCM plant still goesoffline as a result any unfortunate incident, EPCL should have a fixed back-up VCM supplierwith whom EPCL is the primary customer to be served.In addition, realistic future domestic PVC demand, revenue and net income forecast could havelessen the loss that EPCL is expected to report in 2010. According to EPCL in 2009, thedomestic PVC demand was expected to grow at 10%-14% growth for next 3-4 years instead ofthe fact that financial and political crisis had just begun at that time. Now in 2010, EPCL isfacing low demand due to almost no infrastructure development projects in Pakistan and passivebehavior of the market towards construction of homes, which is not only reducing the revenuesbut also increasing losses by charging the same fixed cost and interest charges over the newimported machinery.In order to prevent this in future, EPCL should conduct proper and more importantly realisticforecasting in terms of future demand patterns and revenues. This would not only help EPCL inreducing the risk of low efficiencies but also EPCL would be able to plan future expansions andgrowth plans more productively.8.5 Product and Market DevelopmentWhenever the organization is going through the low demand phase of its products, product andmarket development serves as a savior in such situations. EPCL can increase the uses of PVC byproper research and development.Drip irrigation system is an excellent initiative by EPCL as it not only increases the agriculturalproductivity but also indirectly increases the demand of PVC resin. EPCL should aggressivelypursue the introduction of Drip Irrigation System in Pakistan as it holds huge potential. Furthermore adding to the uses of PVC, unplasticized polyvinyl chloride sheets are commonly used inUS, UK and Australia in construction of homes as it is low maintainenece material. This use can 26
  • 27. Engro Polymer and Chemicals Limitedalso be promoted in flood affected areas where there is urgent need of home building withfinished building material.In addition, market development of PVC resin and Caustic Soda in China and India would helpEPCL cover future low demand of its products in domestic market by selling them ininternational market.9.0 ConclusionEngro Polymer and Chemical Limited holds huge prospects in Pakistani market due to its statusas only PVC resin manufacturer and major Caustic Soda manufacturer in the country. Moreover,the backward integration in the PVC plant strengthened its operations as fully operational VCMplant would not only drastically reduce the raw material cost due to in-house production butwould also increase the entry barriers in the industry because of EPCL‟s cost advantage.EPCL is expected to further grow and turn itself in to profits in coming 3-4 years once againprovided it follows the above proposed strategies and the natural environment remains constant.9.1 Future Financial OutlookAccording to the management of EPCL, the product demand is projected to go down furtherdomestically due to liquidity crunch. The situation is expected to exist till the 1H2011 and thenin 2H2011 the demand is again expected to show some positive signs as the flood relief schemescome in full swing. EPCL is going to focus on export of PVC to China, India and Middle East in2011 to balance the demand and production. The company is also expecting heavy decline in rawmaterial prices as VCM plant will again begin its operation on 100% efficiency from 4Q2010.Plus the prices of PVC and Caustic Soda have risen in the international markets and are expectedto remain at the same level which will further strengthen the top-line of the company.International Chlor Vinyl margins are also increasing in the international market which willfurther lessen the COGS burden on EPCL.Based on these sector and market assumption and provided the internal and externalenvironmental factors remains constant, 4Q2010, Year 2011 and 2012 can be projected as, 27
  • 28. Engro Polymer and Chemicals Limited Heads 4Q2010E Consolidated 2010E Net Sales 3885770 14396500 COGS 3657984 13532710 Gross Profit 227786 863790 Operating Expenses 374247 1247109 Operating Income -146461 -383319 Financing Charges 377042 1394061 Earning Before Tax -523503 -1777380 Tax 209401 672727 Earning After Tax -314102 -1104653 Earning/Loss per share -0.47 -1.77 Rs. In „000‟, except „Earning/Loss per shareHeads 2010E 2011F 2012FNet Sales 14396500COGS 13532710Gross Profit 863790Operating Expenses 1247109Operating Income -383319Financing Charges 1394061Earning Before Tax -1777380Tax 672727Earning After Tax -1104653Earning/Loss per share -1.77Rs. In „000‟, except „Earning/Loss per share 28

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