A little bit of research happened, and I found there's a huge wool pulling scene happening - very interestingly, all legal, so I have decided to open a thread to solve this puzzle.
At a quarterly consolidated EPS of Rs. 47, up from Rs. 36 last year, this is a damn good buy at Rs. 460, no? Heck, that translates to a P/E of 2! For a company growing at 20%! I'm wetting my trousers at the prospect!
Not really. Turns out the auditors have added a tiny little tidbit to the results:
The consolidated financial results include the consolidated financial results of Tata Steel UK Ltd and its subsidiaries whose income constitutes 74% of the consolidated total income. In UK, the pension liability of Tata Steel UK is computed and accounted for in accordance with the International Financial Reporting Standards. IFRS permit the impact of changes in the assets and liabilities due to assumptions of variables like bond yield rates, discount rates, inflation and demographic assumptions to be accounted for in “Reserves & Surplus”. This practice is consistently followed by Tata Steel UK. The Indian Accounting Standard (AS15) is different from the above and requires such changes to be accounted for in the profit & loss account. Given the large share of Tata Steel UK in the consolidated Tata Steel results, and the potential volatility caused by periodic changes in the assumptions underlying the computation of the pension liabilities, it is not considered practicable to adopt a common accounting policy for accounting for the pension liability of the Company and Tata Steel UK Ltd. During the current quarter, the pension funds of Tata Steel UK, with asset base of around £ 14 bn (Rs. 120,000 crores approx), have shown a reduction in the funds’ surplus by around £ 648 million (Rs.5,352 crores). This has been accounted in “Reserves and Surplus” in the consolidated financial statements in accordance with IFRS principles and permitted by AS21. This treatment is consistent with the accounting principles followed by Tata Steel UK and earlier by Corus Group plc. under IFRS. Had the company followed the previous practice of recognising changes in actuarial valuations of pension plans of Tata Steel UK, in the profit and loss account, the profit from ordinary activities after exceptional items and before tax for the current quarter would have been lower by Rs. 5,352 crores.Uhem. I don't like it when companies SUDDENLY change accounting practices, so I decided to venture a little further.The financial results for the quarter ended June 30, 2008 and the pro-forma results for the previous periods have been prepared taking into account the above practice.
So this pension fund has some gains or losses based on interest rate changes, bond yields etc. This is required by Indian law to be reported in the P&L. Last year Tisco took it all into the P&L - a whopping 5900 crores. That was added to the consolidated PAT, and that figure gives a huge Rs. 162 per share EPS. (which is also weird, I'll come to that).
So when it added a whopping 5900 cr. it was perfectly fine to take it on their P&L, but when it showed a loss - and that too at 5,500 cr. loss - they refuse to take it on.
So technically, if the laws were followed exactly as they were last year, Tata Steel would report a LOSS for this quarter.
I then said heck, ok, this is still only actuarial gain, but something's funny in the calculations. So in the annual financials, they have this bit:
They have 73 cr. shares. They have an actuarial gain (let's ignore the rest) of Rs. 5906 cr. The actuarial gain is non taxable so take the PAT - 12,321 cr. Subtract the 5907 cr. - you will get 6,415 cr.
Let's assume zero dilution - at 6,415 cr. with 73 cr. shares, the EPS after exceptional items should be at Rs. 87.88. The dilution should take it even lower, one thinks?
So their diluted EPS report is wrong. Ok, big deal. Even in the latest results they restate earlier data without the actuarial gain and show a diluted EPS of 91.44. It takes around 80 cr. shares duly diluted, but that's a little off.
And they take forex losses as exceptional items (which is weird, because it's setup to offset current costs, so it's by no means "exceptional"). Such losses are technically operational - they are hedges. So are gains, btw, so I'm not one sided on this.
Ok now, how much dilution are we likely to see?
Two levels:
- Some 8 cr. more shares have been issued as convertible preference shares. These will be converted.
- Some 875 million $ shares are issued as foreign currency convertibles - but they haven't been hedged. (so there's a loss there coming up but that's different funda). Okay, so this converts at 758 per share - a value unlikely to be reached in the near future, given current rates are 460. The debt if not converted is nearly 5,000 cr. - not sure if that is added to the debt column (it will increase interest costs) - and if it is converted, will dilute by about 6 cr. shares. (This might already be converted, I don't know)
At 87 cr. shares the fully diluted EPS should be even lower than at 73 cr. shares, no? So last year's EPS figure will be about Rs. 73, consolidated.
The first quarter of FY 09 seems to have been good - they earned more than 5000 cr. of profit from operations. But steel prices are off more than 30% since then. And capital has been tight - so surely impact of that on interest paid will be visible. Will profits drop dramatically? Will these actuarial gains be taken back into P&L if they turn positive? Will the FCCBs be converted? Will preference share dilution impact be taken into consideration?
Such complex questions - and no real answers. At one end you may end up with a P/E of 2. At the other, a P/E of 10.
But the stock price at 460 has been seriously weak.
Here's where I think I must stop believing in reported numbers. I will reject all the bull that that management will throw at me - heck, I could come up with at least three different diluted EPS figures based on my mood at the time. I'll stop believing in reports - who cares if the numbers themselves may be wrong, and seriously wrong. Perhaps the only thing I can trust is price. If the price is falling, something is wrong, and if it's rising something is right. Forget why. It doesn't matter.
No wonder Ed Seykota called them "funny-mentals". I will now keep posts tagged that way - all these funny weird looking things will be noted as Funnymentals.
Now, Would I short Tisco? Fundamentally I might not - because it looks cheap, etc. But that's funnymentals. If there ever was a clear downtrend, this is it. In four months it's fallen from 900 to 460. It's invitation to short - and perhaps belongs somewhere in the SoS. Have to do some more analysis.
On another note: My April 2007 post on the corus buyout seems to be interesting - I was so wrong and stupid. The price I said would happen in October 2007 - 430 to 440 - is close only in September 2008.
Nifty Index EPS growth in Q2 2008-09
Categories: Commentary
How are we going to fare going forward, with a worldwide recession at a minimum and a severe depression at the other end? The Nifty consists of various kinds of stocks and let's see the outlook for them all.
- Oil (26% weight): Outlook is bleak only because oil prices are coming down, and so are refining margins. The refiners will make further lower margins as demand of products (petrol/diesel/etc) come down because of lowered demand in recessions. Some of these companies have huge FCCB loans, which will have to either dilute the stock or be paid at a much higher dollar value, hitting the bottomline. Lastly the oil finds of recent times will need money to explore and exploit - money that isn't going to be easily available. Earnings growth should come down dramatically - from 15% average last quarter to perhaps 5 or so.
- Power and Power Equipment (14.5%): Power is a regulated sector so the plants will have limited profitability. Till now, the equipment vendors have been able to finance and grow customers easily. But going forward, money is less likely to flow into this capital hungry sector - mostly because of lack of available money. So power plants that are "planned" stay on the drawing board, while others cut their aggressive growth plans. That, and again a high ECB/FCCB exposure with a dollar impact, hurts them in the coming quarters.
- Financials (11.36%) - Last quarter they grew -1% on EPS. This quarter will see capital write-downs through sales of ABS, or derivatives, effectively booking the loss. NPAs aren't likely to contract - chances are that they will increase. Plus, bond portfolios will see mark-to-market losses as rates have been increased. I would not be surprised to see a further 1-2% EPS contraction.
- IT (11%): While some companies like Satyam may have some losses with deals with financials, the overall growth is likely to be decent. Rupee's down a lot, and while they would've all hedged, some did take out part of their hedges. The growth was 26% average last quarter (not considering HCL Tech) which I think may pare down to 20%.
- Telecom (10.3%): Should have done well. But there's this whole external borrowing thing that's very weird, and if accounted properly, might cut dramatically into profits. Either ways I expect about 15% EPS growth on average.
- Realty, Cement (totally 6%) - Ok this bit is hosed, and I don't expect anything good out of this. Last quarter cement was down 18% on EPS, and Realty up 13% - this time I expect both down about 20% each. Realty has a weirdo accounting logic so what it really is may not be what is shown to us.
- Auto, FMCG (6%) - Probably will keep EPS stable. Means 0% EPS growth, according to me.
- The rest: There's Pharma, which will get hosed with FCCB but should be defensive otherwise. There's Zee, the only media company, which I have zero opinion about. There's L&T which has a reasonable order book but gets tied down with its dollar exposure (though it's the only company I have a positive outlook on).
Overall I think we'll grow Nifty EPS by even lesser than the 10% we did last quarter. And the Nifty P/E is still 17+. That means the EPS is about 235. A 10 P/E then should mean...well, let's not even go there.The last quarter these guys announced a -18% EPS growth, on average. This time it is likely to be the same or worse. Note here: EPS will dip.
But the problem is the outlook. These guys provide a lot of services to bank and financial service companies abroad. Some of which may not survive the year. And the rest will cut spending like crazy.
Remember that this is all "funny-mentals". There is very little "value" to this information - that is, very little tradeable value, because you never know what will happen, and my assessment is just my opinion. In fact it may be so that I end up being long on the market - because in such markets you change your opinion every day, if not every hour.
While you can't use this info to dictate price, it's interesting that the fundamentals back up the fall in the indices. It's not just an arbitrary fall, like in 2006. It's not an event driven fall like in 2004. This is a huge, massive, bear market. The end is not near, and it's not even the beginning of the end for us in India.
Our news flow, when it comes, will be very bad for the markets. Some of you are thinking: what can be worse than this? One or two days of big deep falls are actually a good time - because you can act. What is worse is 6 months when the index moves, literally, 10 points a day, and mostly down. People lose interest. Nobody "books" their losses - they simply forget they had ever invested. There are no buyers for even the midcaps, and no sellers either, so the market is in some drug-induced stupor.
That's much much worse than this. Imagine two years of say a -10% growth. Nothing scary, nothing to cheer about either. I'm hoping an automated system will do well - we'll see.
Posted in Commentary