Tuesday, June 16, 2020

Investors beware


The public sector capital goods bellwether company Bharat Heavy Electricals Limited (BHEL), reported its earnings for the fourth quarter and financial year ended on 31 March 2020. The numbers were poor and quite off the mark from what the equity research analysts had forecasted. For the quarter 4QFY20, the company reported total revenue of Rs50.5bn (vs Rs103.7 yoy); and for the full year FY20 the company reported revenue of Rs210.9bn (vs Rs304.41bn yoy). The revenue for the quarter was down ~51% yoy; and for the full year it was down ~29% yoy.
The research updates on BHEL by various brokerages raised three points in mind, which I find are critical for investors (especially the smaller one like me) to assimilate. I would like to share these points with the readers as follows:
(a)   In the notes to account, BHEL reported that in 9 days of lockdown (23rd March to 31 March) Rs40bn of revenue was lost. This is appx 39% of the 4QFY19 revenue and 13% of the full year FY19 revenue.
A large number of companies which have declared results so far have reported similar loss of revenue. (Please note I am talking about revenue here not profit). To me this sounds disproportionate for most of the companies.
I have spoken some senior chartered accountants to understand this phenomenon. Most of them informed that it is a regular practice amongst Indian corporates to manipulate the revenue of the month of March. In some cases the revenue of March month is shifted to next financial year (April); and in the other cases the revenue earned in April is accounted for in the month of March. In the last week of the year, some auto and FMCG companies dump inventory to their dealers to book revenue which is not actually earned. Conversely, in cases where the companies want to show lower revenue and/or profit, they book "sales returns" in the month of March and "resale" in the subsequent months.
In case of project oriented companies (real estate, project construction etc), which follows percentage of completion method the practice of manipulating the revenue for month of March could be even more widespread.
Please note that lower revenue booked in the Month of March by most companies is certainly not due to accounting issues, for they get full 3 months to complete the accounts for the financial year and month of March.
(b)   The consensus estimates of various equity analysts for BHEL 4QFY20 revenue was Rs87bn. It reported revenue of Rs50.5bn instead. There have been wide divergences in the analysts' estimates and actual reported number, even when adjusted for no recurring and exceptional items. In past five year, I have noticed, the one year forward Nifty EPS estimates consistently diverging 12-18% from the actual numbers.
This must raise serious questions about the efficacy and utility of the forecasting portion of the equity research function. There is enough evidence that the forecasting by research analysts has been off the mark; still a large number of non institutional investors place material reliance of such forecasts. SEBI must consider making it mandatory for the research analysts to adequately explain the divergence in their forecasts and the actual adjusted numbers; else the analysts may be restrained from making forecasts.
(c)    BHEL is a navratna company. For past one decade it's been racing fast downhill to join the junk yard with MTNL, Air India et al. Quarter after quarter its balance sheet is deteriorating; and revenue & profit growth is declining. No one in the government however appears concerned. Its hard to fathom, why BHEL was not privatized a decade ago, and why it is not being done even today!

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