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Funny-mentals : Tata Steel

I got a mail from Ninad today about how Tata Steels standalone figures had an EPS of Rs. 18, but the consolidated figures including Corus, were released later and found to be Rs. 47 per share.

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.

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.

Uhem. I don’t like it when companies SUDDENLY change accounting practices, so I decided to venture a little further.

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:

Funny-mentals : Tata Steel

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)

That should yield about 14 cr. shares extra. Look at this report from Emkay Research. It assumes an 87 cr. fully diluted equity base – which means I’m close (at least to someone else’s calculations).

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.

Funny-mentals : Tata Steel

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.

  • lucky says:

    >Hello my friend,

    I find your post very detail oriented, analytical and well though out script. Can you shed some background on your education and experience.

    I am an NRI, have great dilemma in whether to keep my savings in NRI savings account or in USD in FDIC insured bank. I remember reading your article about dollar devaluation like 80’s deflation situation. What would be your take.

  • Deepak Shenoy says:

    >Lucky: I am an engineer in Comp. Science, with about 10 years of experience in managing software companies 🙂 As far away as you can get!

    Dollar devaluation: I have to rethink but in relation to teh Euro I think the dollar will appreciate. And so I think with teh JPY too. I’m not very sure of the rupee – I believe the rupee may go down to the 30 levels if the sequence of events is right.

  • lucky says:

    >my question is more of what your opinion about dollar valuation – Like its link to Oil, current financial crises in US and its impact Indian market/Rupee. Our exporter rely on strong dollar, at the same time we are growing more dependent on oil. So Indian govt has to balance the value of rupee at certain level. Primary driver
    more IT job in India is cheap(Rs/$) labor compared to Brazil, Argentina, etc. When you say Rupee might goto 30 which means higher cost to foreign companies and lower revenue on export, IT, etc, which might result in job cut, salary reduction, lower spending capacity and hit real estate boom. What would be equilibrium level when in comes to USD/$ (in your opinion)

  • Rajiv says:

    >Deepak, I am not sure about this “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.”. I guess its not always the case. Price can go up and something behind can slowly get deteriorated as well. It takes time to get reflected in the price. In the longrun, it perfectly holds true.