Acting In Sync

With the market poised to touch a new high, the performance of India Inc’s subsidiaries is more in alignment with their parent firms. ET Intelligence Group’s Ramkrishna Kashelkar guides you on how to evaluate the performance of corporate subsidiaries


DEAR Sir, the EPS given in your story at 13.9 appears to be incorrect. The actual data is 5.9. If this is wrong, then your recommendation is totally false. Please check the same and answer my mail,” wrote one of our readers in response to a stock idea story in Investor’s Guide recently. We were startled. We double-checked the numbers again. The mistake was at the reader’s end. The financial numbers referred to in the article mentioned by the reader were on a consolidated basis. What he was referring to was standalone numbers.
The incident, besides reconfirming our belief that readers of Investor’s Guide analyse every statement, every number that we put out, revealed an important fact. In the complex world of companies financials and their valuations, investors often feel confused about standalone and consolidated numbers. ET Intelligence Group attempts not just to demystify these terms, but also illustrates how these concepts can be used in investment decisions.

REALITY CHECK
Standalone financial numbers indicate the financial performance of a company as a single entity, while consolidated numbers comprise the numbers of its subsidiaries. These subsidiaries could be either acquired or floated and could be wholly or partially owned. It also takes into account performance of associate companies - firms in which the parent company’s control is less than 50%.
Since consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable one to gauge the overall health of an entire group of companies as opposed to one company’s standalone position. Naturally, while calculating price-toearnings (P/E) ratio or evaluating a company, one must always look at consolidated results after deducting minority interest and not standalone results.
Why is it important to consider consolidated results? The main reason is that a company can have a significant chunk of its earnings or liabilities hidden in a subsidiary. For example, in case of Cairn India, the consolidated net profit in FY10 stood at 1,050 crore, while on standalone basis, there was a loss of 69 crore. This happened mainly because it had most of its producing assets under subsidiaries. The company has recently taken steps to merge a few of its subsidiaries with itself, thereby rectifying this aberration to a certain extent.
There will be several such examples. In the case of leading companies such as Sterlite Industries, United Phosphorous, Jindal Steel, Hindalco, Tata Power or Grasim Industries, subsidiaries contribute substantially to their total kitty. It will be erroneous to calculate their P/E ratio or per share earnings using standalone numbers.
However, if you are an investor who gives more emphasis on the track record of dividend payment or bonus issues when investing in stocks, you need to focus on standalone numbers. This is because the annual dividends or issue of bonus shares come from the earnings of the standalone entity, and not consolidated.

RETURN TO PROFITS
The performance of India Inc’s subsidiaries has started improving, of late, which till a year ago, proved to be a burden. Indian companies’ overseas acquisition drive over the past few years had created a number of subsidiaries which underperformed in 2008 and 2009 as the going got tough due to a slowdown. However, we see a turnaround in FY10 and beyond.
In the sample of BSE 500 companies, we found 217 companies providing annual consolidated and standalone numbers for the past five consecutive years. These companies were showing consolidated performance slightly ahead of their standalone numbers in FY07 and FY08. The scene changed in FY09 with consolidated numbers falling more than the standalone ones.
In FY10, the group’s aggregate consolidated profits grew 23% y-o-y as against 19.7% growth at the standalone level indicating a revival. This revival in subsidiaries was accompanied by an improvement in the operating profit margins, with stagnated interest cost.
Two companies, NDTV and 3i Infotech, reported net losses on standalone basis, while profits from subsidiaries helped them post positive numbers. In the case of Suzlon, the profits in subsidiaries were not sufficient to make up for the loss on a standalone basis. As many as 74 companies, or a third of our sample size, still had a net loss in subsidiaries during FY10 - the largest being that of Tata Steel. Its subsidiaries, which include European steelmaker Corus, incurred a loss of 7,056 crore in FY10 as against the company’s standalone profit of 5,046 crore.

WRITING ON THE WALL
Going by the quarterly numbers, one can find the companies where the performance of subsidiaries has started improving, of late. For example, Tata Steel’s losses from subsidiaries turned into profit since the March 2010 quarter. Its results for the September 2010 quarter, which will be announced later this month, will be substantially superior on a y-o-y basis, considering the 3,610 crore of loss its subsidiaries had booked last September.
The problem is that several companies do not publish their consolidated numbers on a quarterly basis. For example, India’s leading electrical equipment manufacturer, Havell’s India, announced a turnaround of its important subsidiary, Sylvania Europe, in the September quarter, which was in the red earlier. The company’s press release mentioned that for the quarter, a consolidated loss of 14 crore last year turned into a net profit of 71 crore. However, the company had stopped publishing quarterly consolidated numbers after FY09. Together They Unlock Value
IN OUR sample size, quarterly consolidated numbers are available for nearly 150 companies. Tata Motors is a leading example of how a turnaround in subsidiaries is boosting its earnings. The turnaround of Jaguar Land Rover (JLR), over the past couple of quarters, has led to the subsidiaries contributing nearly 80% of its quarterly profit. Similar is the case with Dr Reddy’s Lab. After posting an operating loss in the December 2009 quarter, it has reported a gradual improvement at the operating level in the subsequent quarters. In the September 2010 quarter, it reported a healthy operating margin of 22.7%, thanks to improvement in its subsidiaries. Lupin, Mercator Lines, United Phosphorous are similar such examples of firms that have seen turnarounds in their subsidiaries in the past few quarters.

VALUE UNLOCKING
Sometimes subsidiaries are also like hidden gems as the value in them can be unlocked in due course and can give a booster to the parent company’s valuation. For example, a recent IPO of Orient Green Power (OGPL) might have lost money for its investors, but boosted the valuations of its parent Shriram EPC. The company’s market capitalisation gained 50% within a span of just two months on OGPL filing the draft prospectus in April 2010.
There are several other companies planning to unlock value in their subsidiaries at an opportune moment. The engineering behemoth L&T has long been planning to list its various subsidiaries, particularly the IT and finance ones, to unlock value. Other companies, such as Ballarpur Industries, GE Shipping and Glenmark, have plans for listing their subsidiaries.
This analysis takes us to a method of choosing the future winners. Companies - particularly those which publish consolidated numbers only once a year - are likely to be undervalued if fortunes of their subsidiaries have changed. Investors should, therefore, do well to know the businesses and geographies of the key subsidiaries of companies and track their performances consistently to make investment decisions. Remember that investors of Tata Steel, when it had posted its largest consolidated quarterly loss in the March 2009 quarter, would have tripled their money by today.