Brokerage and investment research firm CLSA report on Indian stocks which may head for downgrade due to stock specific reasons. This report is very helpful for retail investors who generally do not have access to research information. These and many other stocks mentioned below are likely to face severe de-rating in the coming months, as the deliberate RBI policy to keep the Rupee weak implies a permanence in FX losses
Corporates like Jaiprakash Associates have chosen not to account for losses on FX exposure in the accounts for the first half of FY09. As per current calculations, the company will lose about Rs 3 per share in earnings post-FCCB accounting. Losses of this magnitude when accounted for will make JP's result move into RED by end of FY09.
These and many other stocks mentioned below are likely to face severe de-rating in the coming months, as the deliberate RBI policy to keep the Rupee weak implies a permanence in FX losses (Accounted or not) as the Central Bank has carried out a 20 per cent competitive devaluation of the Rupee against the Dollar, just like so many South East Asian nations and those in South America.
Indian stocks: risks to valuations
Background:
Indian markets have in the last few years traded at a premium to other regional markets because of better corporate governance, superior disclosures, high management quality and better capital productivity, apart from superior and consistent earnings growth. In a scenario of rising risk aversion, investors will take a tougher view on companies that adopt 'aggressive' accounting policies, even if these are in line with prevailing accounting standards.
This will reflect in the de-rating of such stocks, relative to peers that adopt 'conservative' accounting policies. During 1QFY09 we have seen a number of companies resorting to accounting policy changes, charging FX losses to balance sheet, subsidiary stake sale to group entities and other accounting practices to buoy reported profits.
Permitted, but not best practices:
Capitalization of FX losses on FX debt, Forex contracts etc. Forex losses on translation on FCCBs not being recognised under the assumption that FCCBs will necessarily be converted.
Losses on outstanding FX derivatives, while being disclosed, have not been provided for in the P&L as per AS30 (most companies do not follow AS-30 as it becomes effective from 2011)
Transfer of assets to subsidiary companies or group companies to boost stand alone profits and without any clarity on valuation methodology or justification of the same. Increased instances of related party transactions are visible.
Companies adopted changes in depreciation policy and revenue recognition policy to buoy profits or revenues.
Fudging up Accounts, in a permitted way:
15 stocks are likely to face a severe de-rating in stock markets:
1. Anantraj Industries:
A North Indian commercial developer, transferred part of one of its projects (0.52mn sf out of 0.75mn sf in a mall in Delhi) to its wholly owned subsidiary and consequently showed equivalent revenues in its standalone results (93% of 1QFY09 revenues).
As against standalone revenues of Rs1.72bn and net profit of Rs1.52bn, consolidated revenues are Rs104.8m and net profit of Rs77.6m. Out of the consolidated revenue of Rs104.8m, Rs68.05m (65%) is from the ceramics business.
2. DLF:
DLFs non-DAL revenues declined 44% QoQ to Rs22.5bn and around 40% of sales have been to DAL, a group entity. 44% of debtors are DAL and of total debtors, the share of DAL has increased during the quarter with DAL receivables increasing by Rs14.5bn QoQ.
During 1QFY09, sales to DAL were Rs15.6bn, which is marginally higher than the increase in receivables from DAL. We would like to add that DLFs high level of transactions with group company DAL and high level of receivables has been a point of debate since it went public.
3. Dr Reddys Labs:
Dr. Reddy's has adjusted mark to market losses on outstanding US$250m of hedges in balance sheet, while P&L reflects forex gains realised. The company also reclassified its contract manufacturing business (CPS) revenues into API and Formulations, which makes it difficult to analyse its segmental performance.
4. Himatsingka Siede:
Himatsingka in one derivative contract had mark to market losses of US$41.5m as on March 24, 2008 and no provision has been made since the company has filed a case in court against the concerned bank. In case of another derivative contract, mark to market loss of Rs1.58bn as on 30th June has not been provided for since the derivative contract is still open.
5. HCL Tech:
HCL Tech has normally had a very large hedge position compared to its revenue base. While the rupee was appreciating, the company reaped benefits of this and reported US$79.2m in Forex gains in FY07. The company has always maintained that it would prefer to lock-in a constant INR/US$ rate through hedging rather than suffer from the currency volatility.
However, the company unwound US$540m of hedges in Jun-08 and booked large Forex losses. We find this change in Forex policy surprising and the company has likely brought forward its potential FY09 FX losses to 4QFY08 through this change in policy.
6. JP Associates:
Jaiprakash Associates did not provide for FX losses on outstanding FCCBs of US$400m through its P&L and plans to provide for the FX losses/ gains at the end of the year.
7. Jet Airways:
Jet Airways changed its depreciation policy from WDV to SLM, and thereby wrote back Rs9.2bn into its P&L, which helped the company to report profits during the quarter. It also helped Jet to report higher net worth, which will help in keeping reported gearing low. This is a one-time exercise. Jet also capitalised Forex loss of Rs6.2bn on Forex debt and adjusted it against carrying value of fixed assets.
8. Prajay Engineers Syndicate:
Hyderabad based developer, reported a loss in its fourth quarter results against expectations of a profit. The company "lost" records for a project worth 40% of its annual revenues at the site office.
The company in its press release said - "After the year end, basic records relating to sale agreements / revenue and construction expenses of one of the Projects of property development were lost at the site office, Vishakhapatnam. The auditors in their report have stated that they were not able to verify the books and records relating to income of Rs1437.71m and relevant construction cost of Rs752.654m. Management is making all efforts to locate/ retrieve the lost records."
9. Ranbaxy:
Pharma major has mark to market losses of Rs9.09bn on forex derivative contracts, which have not been provided for because the company believes "the gain on fair valuation of underlying transactions against which the derivative transactions were undertaken amount to Rs10.3bn." This argument is against the principles of conservative accounting wherein mark to market losses are being offset against assumed future profits.
10. Reliance Communications:
Telecom Company has adjusted short term quarterly fluctuations in foreign exchange rates related to liabilities and borrowings to the carrying cost of fixed assets. The company adjusted Rs1.09bn of realized and Rs9.55bn of unrealized Forex losses in the above manner.
In addition, the company has not recognised Rs3.99bn of translation losses on FCCBs, since the FCCBs can potentially get converted, although the FCCBs are out of money. Adjusted for all the above, the company would have virtually no profits in 1QFY09.
11. Reliance Industries:
In continuance of its policy, adjusted "foreign currency exchange differences on amounts borrowed for acquisition of fixed assets, to the carrying cost of fixed assets…which is at variance to the treatment prescribed in AS11." Had AS11 been followed, profits for 1QFY09 would have been lower by Rs9.4bn (23% of reported net profits).
12. Sobha Developers:
South Indian developer changed its accounting norms in 1QFY09 for revenue recognition which facilitates revenue being recognized earlier in a project cycle. According to its press release, if the accounting policy had not been changed, the company's 1QFY09 PBT would have been lower by 20%.
Excerpts from the company's press release: "With effect from April 01, 2008 the Company has changed its accounting policy for revenue recognition for sale of undivided share of land (group housing) on the basis of certain minimum level of collection of dues from the customer and / or agreement for sale being executed rather than criteria relating to the project reaching a significant level of completion to align it with revenue recognition policy for sale of villa plots.
This has been resulted in additional revenue recognition and higher profit before taxes of Rs321m and Rs150m respectively during the quarter ended June 30, 2008."
13. Tata Motors:
Company has transferred 24% stake in Tata Automotive Components (TACO), a company with revenue of US$675 in FY07, to Tata Capital, a group company, and booked profit of Rs1.1bn in 1QFY09. Management has declined to disclose the valuation methodology.
Senior management of Tata Motors, in a conference call with analysts, said, "I would not be able to share with you the specific valuation methodology, except to say that the things are done by an independent reputed firm and based on the company's track record and the future business opportunity."
Tata Motors has also changed its methodology for calculating provisions for doubtful receivables, which resulted in higher reported EBITDA to the extent of Rs507m (10% of EBITDA).
14. TCS:
The software major increased its depreciation policy on computers from 2 years to 4 years. As a result, 1QFY09 PBT was higher by an estimated Rs500m (c.4% of net profit in 1QFY09). TCS follows cash-flow hedge accounting and till FY08, it used to recognise hedging gains on effective hedges in its revenue line, thus boosting the reported revenue growth and EBIT margin.
In FY08, TCS had Rs4.21bn from hedging gains, of which, Rs1.37bn was included in the revenue line. However, from 1QFY09, TCS will report all Forex losses/gains below the EBIT line in other income. Thus the losses it had on its hedge position will no longer be booked in the operating line.
15. Zee Entertainment:
Media company withdrew its buyback offer "for the time being" without assigning any other reason. This happened after SEBI made it mandatory that companies will have to complete the entire buy back within the stipulated time, if the stock is trading below the maximum buy back price at the end of the buyback period and the buyback amount has not been completed.
Nothing in this article is, or should be construed as, investment advice.
Source: CLSA. Thanks to Dr. Krishna for publishing this report.
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