practitioners approach to financial analysis

Practictioners’ Approach to Financial Analysis

Important Disclosure: All data, information, examples discussed here for academic purpose only. Nothing contained in this document should be construed as an offer to buy or sell any securities.

Ashok Jainani

Khandwala Securities Limited

MUMBAI - 400 0023

MFC, DFSUniversity of Delhi, South Campus

September 19, 2009

Contents

• Introduction

• Approach to Ratio Analysis

• Innovation

• What Works

Khandwala Securities Limited 2

September 2009

It’s all your positionFrom where you look

Mind takes shortcutsAnchors guide your outlook

>>

>>


September 2009

What Do These Figures Say

• Jay Bharat Textile Ltd• Market Cap ~ 14,000 Cr• Owner Comment: Cautious 27 33PAT

488 424Revenue

FY2009FY2008INR Cr

70 69PAT

417 367Revenue

FY2009FY2008INR Cr

Don’t Understand, AVOID

• RNRL• Market Cap ~ 14,500 Cr• Court Case Continues


September 2009

• Company• Shareholder• Fund Manager• Analyst

• None of the Above• Valuations don’t always drive prices• Liquidity – Financial (flows), Market (volumes) MMTC• Fundamentals over long term, what about short term• Technicals – shadow, not determinant but anchor projections• Sentiment• Market Dynamics

Who Decides Right Value


September 2009

-3

0

3

6

9

12

15

Jan-08 Jun-08 Nov-08 Apr-09 Sep-09

(%)

210

220

230

240

250Inflation YoY WPI Index (RHS)


September 2009

Inflation

Financial Statement Analysis

• Financial Statements• A Possible Framework for Analysis• Ratio Analysis• Trend Analysis

• BondholdersBondholders -- Focus on long-term cash flow of the firm• ShareholdersShareholders -- Focus on profitability and long-term health

of the firm


September 2009

Frame Work for Financial Analysis

Health of a FirmHealth of a Firm

Financial Ratios

1. Individually

2. Over time

3. In combination

4. In comparison

Analysis of the financial Analysis of the financial condition and profitabilitycondition and profitabilityof the firmof the firm..


September 2009

Frame Work for Financial Analysis

Analysis of business riskAnalysis of business riskof the firm.of the firm.

Business riskBusiness risk relates to the risk inherent in the operations of the firm.

ExamplesExamples::– Volatility in sales– Volatility in costs


September 2009

Liquidity Ratio Comparisons

Current RatioCurrent Ratio

MW Industry

2.39 2.15

2.26 2.09

1.91 2.01

Year

2008

2007

2006

Ratio is stronger than the industry average


September 2009

Liquidity Ratios

Balance Sheet Ratios

Liquidity Ratios

Shows a firm’s ability to meet current liabilities with

its most liquid assets.

Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InventoryCurrent Assets - InventoryCurrent LiabilitiesCurrent Liabilities

For Market Wonders December 31, 2008

1,195 – 6961,195 – 696500500

= 1.001.00


September 2009

Liquidity Ratios Comparison

Acid-Test RatioAcid-Test Ratio

MW Industry

1.00 1.25

1.04 1.23

1.11 1.25

Year

2008

2007

2006

Ratio is weaker than the industry average


September 2009

Summary: Liquidity Ratios Comparison

Ratio MW Industry

Current 2.39 2.15

Acid-Test 1.00 1.25

• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.

• Note that this industry has a relatively high level of inventories.


September 2009

Summary: Liquidity Trend Analysis

• The current ratio for MWMW has been rising at the same time the acid-test ratio has been declining.

• The current ratio for the IndustryIndustry has been rising slowly at the same time the acid-test ratio has been relatively stable.

• This indicates that InventoriesInventories are a significant problem for MW.


September 2009

Activity Ratio Comparison

Inventory Turnover RatioInventory Turnover Ratio

MW Industry

2.30 3.45

2.44 3.76

2.64 3.69

Year

2008

2007

2006

MW has a very poor inventory turnover ratio

Total Asset Turnover RatioTotal Asset Turnover Ratio

MW Industry

1.02 1.17

1.03 1.14

1.01 1.13

Year

2008

2007

2006

MW has a weak total asset turnover ratio.Why is this ratio considered weak?Why is this ratio considered weak?


September 2009

Profitability Ratio Comparison

Gross Profit Margin (%)Gross Profit Margin (%)

MW Industry

27.7 31.1

28.7 30.8

31.3 27.6

Year

2008

2007

2006MW has a weak Gross Profit Margin.

Net Profit Margin (%)Net Profit Margin (%)

MW Industry

4.1 8.2

4.9 8.1

9.0 7.6

Year

2008

2007

2006MW has a poor Net Profit Margin.


September 2009

Profitability Ratio Comparison

Return on Investment (%)Return on Investment (%)

MW Industry

4.2 9.8

5.0 9.1

9.1 10.8

Year

2008

2007

2006

MW has a poor Return on Investment.


September 2009

• Just Strong bottom line doesn’t tell truth,

– What is also required

• Sustainability of PAT growth

• Elements of bottom line

• Future outlook of the industry/company

Which figure is the triggerfor buy or sell decision


September 2009

Double Check• Power Cost Up• Transport Cost Down• Volumes Flat, Revenue Up• What does it mean ?• Price inflation, but power/freight don’t match• Inventory Clearance, again don’t match• Are goods actually moving ?• Power/Diesel cost pilferage


September 2009

Which is a good buy, company 1 or 2?

3.920.4Company 2

2.015.7Company 1

P/SP/E

What Is A Good Buy


September 2009

22

17

Cash/

Share

37.845.025.86.93.920.4Company 2

25.541.120.29.22.015.7Company 1

ROE (%)

ROCE (%)

EBITDA (%)

EV/ EBITDA

P/SP/E

• Now look at the big picture

• Ratio needs to be seen from

– different angles

– wider perspective

– compared on different performance parameters

– in combination of other ratios and industry standards

A Good Buy or Good Bye


September 2009

• Company 1 – HCL• Company 2 – TCS

• What is beyond Fundamental – Market Reputation of TATA

No, We are TATA


September 2009

PE – Fair or Mean

10 yr CAGR (%) 15.0 18.0

Discount Rate (%) 10.0 9.0

Current EPS (INR) 100.0 100.0 Target Yr EPS (INR) 351.8 443.5 Dis ValCum EPS (INR) 1,231.0 1,411.5 PE 12.3 14.1


September 2009

Is Investing Simple ?


September 2009

Investing is Simple

• Will this Company be there after ten Years?

• Will this Company make more profit in future than What is making today???

• Good Company not necessarily a Good Investment• HUL – Good Company, Bad Stock• Good Investment in Bad Market

- RIL (’92), Infy (’00)

• Bad Investment in Good Market- HFCL, Pentamedia

• Bad Investment in Bad Market, …


September 2009

Year Cos Listed New Listings 1992-93 2,861 8681993-94 3,585 9831994-95 4,702 1,5481995-96 5,603 1,5911996-97 5,832 8011997-98 5,853 891998-99 5,849 331999-00 5,815 692000-01 5,869 1282001-02 5,782 62002-03 5,650 52003-04 5,528 352004-05 4,731 512005-06 4,781 1282006-07 4,821 1142007-08 4,887 111

-982 578

Where do they go?

Source: BSE, SEBI 2008 Handbook, Companies listed on BSE


September 2009

Is It So

• Hind Motors - Maruti Suzuki• Usha Steel, Rajinder Steel - Tata Steel• Infosys Technologies - Pentamedia Graphics• Centurion Bank, Bank of Punjab - ICICI Bank• E and I same for all, value of C• Management, Vision, Capability


September 2009

Hero Honda vs LML


September 2009

• Top Down or Bottom up

• Current situation

• Financial crisis required the all the analyst to revise their economic outlook resulting in revision of valuations (de-rating)

• If with the particular news about the company or changes in the company it becomes attractive- you adopt CIE

• Can we believe politicians

Where’s The Treasure ?


September 2009

• EIC –50%-30%-20%

• Company should be given more importance

– More frequent company news cause movement in stock prices

• To factor in only the important news

– Company valuations do no change frequently unless very important

– All important news needs to be viewed from long term perspective

• Stock prices fluctuate continuously due to sentiments

- Essar Oil 50% up (6th Apr ‘09) – rumours of likely delisting

– RNRL 26% up (11th Dec ‘08) - court verdict

– RNRL rose 15% on (15th Jun’09) - due to high court verdict, which was only the temporary change in the fundamental, as the case is still pending

News or Noise


September 2009

Note: * O/S Credit Book/Total Industry Credit** Revenue from Value Added Services as a Percentage of Total Revenue*** Number of times of Operating Cashflows excluding working capital changes that covers the outstanding debt# Net Realization / ton## Average Realization / KW### Replacement Cost ( EV/MW)^ (P/E)/ Expected 1 year forward growth rate@ Order Book/ Sales

Banking, FSI IT Telecom Auto Metals Power Cap Goods

RoE (%) RoE RoE RoE RoE RoE RoE

ROA (%) RoCE RoCE RoCE RoCE RoCE RoCE

P/ABV P/E P/E P/E Cash/Share ##AR/Ton ̂PEG

NIM (%) P/S ARPU P/BV #NR/Ton EV/ EBITDA @OB/S

*Credit/Inds (%) EBITDA (%) EV/ EBITDA EBITDA (%) EBITDA (%) EBITDA (%) EBITDA (%)

Cost/Income (%) EV/ EBITDA EV/ Subscriber ***D/ EBITDA *** D/ EBITDA ***D/ EBITDA ***D/ EBITDA

Net NPA (%) Cash/Share **VAS (%) EV/ EBITDA EV/ EBITDA ###N/Cton EV/ EBITDA

Key Differentiators


September 2009

Innovation

0

15

30

45

60

75

Mar-07 Dec-07 Sep-08 Jun-09

(%) SBI ICICI

32

63

12

17Cap/Credit


September 2009

Sensex/Gold Ratio

0.00

0.20

0.40

0.60

0.80

Apr-92 Aug-96 Dec-00 Apr-05 Aug-090

5,000

10,000

15,000

20,000Sensex/Gold Sensex (RHS)


September 2009

What Works On Dalal Street

• Big Numbers Miss Real Figures

• GDP, IIP, corporate sales, and EBIDA margin have very low correlation with Sensex gyrations

• It’s the liquidity – real juice and the interest rate differential - that determine the market pulse

• Honesty: Transparency, Unbiased, Responsibility for Actions

• Consistency: Job knowledge and consistency of performance


September 2009

Thank You

Important Disclosure: All data, information, examples discussed here for academic purpose only. Nothing contained in this document should be construed as an offer to buy or sell any securities.


September 2009

practitioners approach to financial analysis

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