Key takeaways from Reliance Industries Annual Report for 2015-16

It is not everyone's favourite pastime to open a 400+pg annual report, but I could not resist the urge to read the RIL annual report once it was released. Here goes my takeaways(in no particular order). Those interested can download it from http://www.ril.com/getattachment/56a9a0bd-d1e1-4735-9e8f-ece1e7e71e87/AnnualReport_2015-16.aspx

• As versus prescribed CSR spend of ~56 crores, they have spent ~67 crores. Interestingly, nearly 90% of this is via Reliance Foundation and not directly.
• They have a CFO and a Joint CFO, who earn Rs 14crs and 11crs respectively. The division of work between them is not too clear
• Pg 13 and Pg 53 highlight Reliance's products in everyday life, and the product cycle chemistry. This is a must read for everyone
• Mukesh Ambani has accepted remuneration of ~40% of his approved limit, in an effort to set a personal example for moderation in managerial remuneration. 
• Jio's strategy seems similar to Wechat, in my view, considering the wish to integrate payments, communication and ecommerce. Would be interesting if they succeed.
• On reading the ambitious plan for Jio which would account for ~20% of group capital employed, I decided to hunt for reviews of the pilot launch. This link(http://techpp.com/2016/05/26/reliance-jio-apps/) is not very complimentary of the user interface, and therefore apps like Magzter, Netflix could rest easy for some time
• Under Prabir Jha, Reliance had switched to employee friendly initiatives like a 5 day week, RALP etc. But now, there is hardly any mention of HR in the report. While Reliance has a good employee brand (maybe not among IIM graduates but overall), the report could have focused more on building this
• The company is VERY science  and technology focused  as evident from the space devoted to the discussion. 
• Reliance achieved a 7yr high GRM/barrel of $10.8, which it attributes to  The ability to operate at high utilisation levels and switch product slate to suit market conditions enabled RIL to capture margin optimisation opportunities in the market.
• Under an innovation program GenNexHub, the company encourages startup via incubatio as follows: During the four-month-long programme, GenNext Hub conducts workshops and mentoring sessions for start-ups in the areas of customer development, market traction, operations, product roadmap, fund raising and pitching. It also provides expertise in IP, legal, financial compliance, HR and specific sectorial expertise. GenNext Hub is uniquely positioned as a global programme that helps start-ups think big and grow fast. This seems inspired by Rocket Internet, since the areas are not too relevant to Reliance. 
• The financials were not too insightful but that is only to be expected from a company audited by the Big4. 

How management affects financial reporting-the case of Tata Power and Adani Power

As a veteran reader of annual reports would know, accounts (even audited ones) are subject to several adjustments/interpretations. This is because on the same facts, different people can take the same view. Auditors merely ensure that the management interpretation does not cross canons of incorrectness.

Facts in brief
Adani and Tata had bidded for coal based power plants respectively with capacities tied up under power purchase agreements (“PPAs”) for twenty five years with substantially fixed tariffs. The PPAs for these plants were made based on the commitments / understanding that domestic coal linkages would be available to meet the fuel requirements. However, adequate coal linkages were not made available due to various reasons not attributable to the respective subsidiary companies. In response to pleas for compensating the losses due to above, the respective state electricity regulators had granted part relief in form of interim compensatory tariffs, however this matter was litigated and has not reached finality as of now.

Stance taken by Adani Power-Recognize revenue
As per the assessment by the Management, it would not be unreasonable to expect ultimate collection of an equivalent amount as the CT towards relief due to impact of Force Majeure events which is predicated on the legal advice that the CERC may be guided by the principles of restitution / mitigation of the impact of the promulgation of the Indonesian Regulations and non-availability of short supply in determining the extent of impact of Force Majeure events. In view of the aforesaid, the Company has continued to recognise total revenue of H3,374.66 Crores on account of the CT upto 31st March, 2016 (including H674.19 Crores for the year ended 31st March, 2016 and H857.35 Crores for the year ended 31st March, 2015) based on the formula and methodology prescribed by CERC vide its order dated 21st February, 2014 considering the same as the most appropriate basis for measuring impact of the Force Majeure

Stance Taken by Tata Power-No revenue recognition-Director's report for FY 2015
CGPL has been legally advised that it has a good arguable case. However, in view of the pending appeal as mentioned above and considering that the amounts associated are significant, CGPL has not recognised revenue amounting to ` 757.89 crore for the year ended 31st March, 2015 and ` 1,019.06 crore for the period from 1st April, 2012 to 31st March, 2014. 
Above stance not expected to change as the company has not recorded this income in the audited accounts for the year ended 31 Mar 2016.


Takeaway
Both the below companies are audited by the same Big 4 auditor Deloitte. Yet on very similar facts and the identical rulings, the companies took a very different view to revenue recognition, and the . Tata Power conservatively chose not to record revenue considering the high stakes involved, while Adani Power decided to record it basis management assessment. Accounting risk is therefore higher in the latter, from an investor perspective. While the statutory auditor has qualified the audit report in Adani possibly for this reason citing it as an internal control weakness, this is more a process rebuke than calling it wrong accounting
According to the information and explanations given to us and based on our audit, a material weakness has been identified as at 31st March, 2016 in the Company relating to inadequate internal financial controls over financial reporting in respect of revenue recognition on account of additional tariff claims pending determination by regulator, and final outcome of the litigations.

Interesting nuggets from company quarterly results from Jan 1 to Jan 25,2014

As per the quarterly reporting calendar mandated by the Indian securities regulator SEBI, listed companies are supposed to release their quarterly income statement within 45 days from end of the quarter(and balance sheet every half year). Notes to accounts are also mandatory, and while often overlooked, give very interesting information which could otherwise be overlooked, or only mentioned by discerning news sources like Mint newspaper. Why should investors bother? All these are issues which go directly to the quality of earnings considerations, and warrant a relook at the investment thesis, as also early warning flags even if not highlighted in company press releases

Following goes
1) In Note 3 of its results, CAIRN INDIA disclosed an one time P&L charge of Rs 1555 Mn(around Rs 1395 Mn post tax) on account of measuring its outstanding employee stock options via Black Scholes method instead of intrinsic value method(only accountants would really go into these details). While this impact was hardly 1.5% of the year to date PAT, it was still quite interesting to see such large impacts and the timing of this non mandatory charge-maybe cleaning up the books to reduce CSR charge? http://www.bseindia.com/xml-data/corpfiling/AttachLive/Cairn_India_Ltd_230114.pdf

2)In their report annexed to DISH TV financials, the auditors i.e KPMG flagged attention to the erosion in net worth, non renewal of license(till date, though mere formality), and the company's mismatch in depreciating CPEs over 5 yrs, but booking the advance revenue in 3yrs. This was probably another long drawn audit unadjusted difference, which the company expensed this time  http://www.bseindia.com/xml-data/corpfiling/AttachLive/Dish_TV_India_Ltd_230114.pdf

3)THERMAX Group expensed nearly 10% of their previous years profit(i.e 10% of 350 crores cf Rs 35 crores)  being provision made for estimated liability likely to arise upon its claim for deduction of certain business expenses being held inadmissible consequent to a survey u/s 133A of the Income Tax Act This was despite not having received an order after the survey!! Usually companies vehemently contest the charges as being without merit etc, but Thermax seems to have rolled over! Also, the closure of the Mundra SEZ unit for not having received environmental clearances, affected this quarter http://www.bseindia.com/xml-data/corpfiling/AttachHis/Thermax_Ltd_210114.pdf

4) ASHOK LEYLAND credited the net profit around Rs 14 crores, from sale of immovable property to its profit and loss instead of directly to equity via general reserve. This change was done this quarter i.e Dec13 onwards, just when the company shifted into losses! http://www.bseindia.com/xml-data/corpfiling/AttachHis/Ashok_Leyland_Ltd1_210114.pdf

5)In KEMROCK financials, the auditor drew attention to the debt restructuring of the company referred to in Note 5 of the financials, which are missing!! 4!!! http://www.bseindia.com/xml-data/corpfiling/AttachHis/Kemrock_Industries_and_Exports_Ltd_160114_Rst.pdf

How chartered accountants can lead the business

This post is a transcript(non verbatim) on best efforts basis of the webcast available at (http://spotforge.net/live/icai300812/). Copyright not claimed-I guess it vests with ICAI. Please do not quote without approval from ICAI and the speaker.  The talk was by CA. Sunil O. Khandelwal,Chief Financial Officer, Alok Industries Limited. He is also Chairman, CMII. The topic of the webcast was  Skills of CA- CFO  CA- CEO ;  CA- Entrepreneur. He has 23 years of experience in the same company(Alok) and has grown to become CFO, yet humbly says that does not claim to have learnt his job fully. Without much ado, let us read the tips below. Caution they said is 2hrs training will not make someone a CEO/CFO etc(not even management books do so!), but guidance on what to imbibe.

1. Charming Futuristic Optimistic(CFO)-if CFO does not have a smile on face giving confidence to top management and others, while working on problems in mind. Ideally, crisis should come and go without people getting alarmed, don't show off-true quality of CFO is to give comfort, act on time.
2. Caring for organization/Company's full ownership-feel as if you are the owner of the company-give your 100% commitment. Leadership is the 'mindset' not the designation. Organization always watches you how sincere/committed you are, then only advances you.
3. First few years of the career should go to build your knowledge base/understanding of the company. He has 23 years of experience in the same company, and everyday learns something new/new way of doing the same company like raising funds etc.
4. What is finance-some feel nothing but giving projections about the company-revenue/profits/cash flows. But unless you know the ABCD of balance sheet/critical aspects, how will you project it? So do not resist doing job of accountant. Don't be hurry to become CEO/CFO on Day1. Take whatever comes your way, show your capability by being meticulous and giving suggestions on controlling cost/areas of improvement, by using your knowledge of the company.
5. CFO should be champion of Finance Operations-oath to organization that I will meet all the financial obligations of organization in time and at lowest cost.
6.  He learnt and grew along with the company for IPO/project finance/QIP/overseas M&A/FCCB  etc, but still feels he has a long way to go in learning. Accountant(first 4-5yrs), then taxation/finance/audit role expanded, then as company grew scope shifted to raising finance. As the company grew, they further began to specialize, so delegation is the new skillset needed.Job of leader create everyone in organization capable of becoming CFO.
7. Championing Financial Information and compliance-setting up SAP/Oracle, accounting systems etc. When asked about SAP implementation, he said that his only decision was deciding to go ahead with SAP, and praised his implementation team for doing it seamlessly[he did not even need to get involved hands on].
8. One of the major job of CFO is ensuring covenants met on time. Also, interacting with equity research/bankers and keeping them updated about the company. CFO represents company to all stakeholders-bank, auditors, consultants, media, investors, Govt, internal, public at large, and therefore strong hand in communications/marketing/website. 
9. The definition of CFO that he has learnt in the last one year is Champion of Full Operations of the Company. Not only having full knowledge of operations but also getting Contribution From Operations. Hence, not only monitoring/review system but also making it profitable using our financial acumen/knowledge. Focus of production guy is quality products, marketing is what sells but CFO focus is truly finance/costs and can advice functions accordingly. Also, not only raising working capital for the company but also reducing working capital cycle/ensuring that it is effectively used.
10. Ensure FCF(Free Cash Flow=Cash Flow from Operations-Working Capital Increase-Capex) positiveness, which bankers and investors like. Make people aware about importance of capital/return on capital. Functions may like capital rich model(buffer stocks, excess capacity, product variety), but Finance must step in.
11. Be aware about business environment, to effectively strategize. Importance of R&D(not just Apple/Pharma company)-so CFO needs to have eye on future-innovation.
12. Making business sustainable In good environment(high demand, low cost) its easy, but under any circumstances(SCM bottlenecks, demand low, cost high, less funds, FX risks), how to make business model sustainable->effective external risk management and manage internal risks-actively participate and take ownership. Sustainable cash flow(ensuing from profitable operations) is must. Even if operations temporarily loss making, still manage cash flow by managing working capital(stretching creditors, liquidating debtors/inventory). Conversely, ensure that additional sales not from increasing debtors/inventory of company-which leads to negative FCF.
13. Has to be effective HR guy, not only within division but beyond, to inculcate that vision etc even till the shop floor also. So use experience to suggest HR practices like ESOPs/profit sharing/target linked incentives etc, for financial impact. Also, quality initiatives-ISO/process engineering. "If you don't drive the business, you will be driven out of the business"
14. While answering audience Q&A -About decision making, interesting practice in Alok that of 8 member management committe(including promoters etc), atleast 5 of 8 have to agree else proposal is withdrawn. About cost reduction, advices that sustainable suppliers also needed, so negotiate as per supplier need(immediate payment cash discount, help supplier open L/C with bank, volume discounts, reduce cost of sourcing by inventory management etc, keeping them informed proactively if payment details, e-bidding for pre qualified bidders). When asked about a difficulty faced, said that everyday is a challenge to win the battle, especially for highly geared company(!), for example he said that stock hammered down 30% in past few days and they have to face those stakeholders openly & confidently.When asked about life of CFO, joked that his wife is his second wife(job is first wife!). If his company is doing well, his family will be proud. Rajkumar Adukia said that for those mobile, the world is their playground. Family needs to be taken care but ideally tell them 'I am there for you but priorities are XXX'-he had missed moments but has no regrets as family is ok-if he's not in office he's at home-no social life partying etc.

Wellknown consultant CA RajKumar Adukia advised on how a CA can become a business leader, focusing on mindset(can-do, fire in the belly). He also said that inquiring attitude(to add value to that activity/reduce its cost) via professional skepticism, is the best learning from the CA course. CA should play role of doctor(solution giver) not of policeman! Use sound technical knowledge, ability to meet deadlines(honed under articleship training) while working under pressure, and good analytical ability to add value.  Five minimum qualities for professional as per him acronym KILL P

1. Knowledge A professional should not have any boundary for knowledge(keep learning till we retire in profession) and achievement(strive till the last breath despite limitations ). Else, even senior people(say President Finance) may not be functional leaders if they need to ask VP/Sr Mgr for each and every new thing/amendment! Have inquiring attitude of general knowledge/learning. He also advices seminars, post qualification courses etc.
2. Interact with persons smarter than oneself
3. Listening very attentively when we are in meeting/GD, and THEN give our response. He observes that even practising CAs listen to clients for 5mins, quote a fee, and then when complexity unfolded fully, they regret that should have quoted more. 
4. Learn from mistakes of others Many success stories of CEOs who are CAs vs those who have not excelled, try to compare and contrast. Books/Code of Ethics are also a good way.
5. Making presence felt by writing/speaking etc, on burning issues/analysis etc. Rajkumar Adukia himself is himself an expert on this-just see his website! Also, one needs executive presence to be able to assume leadership roles one day. Developing and learning soft skills(presentations in branches/chapters/study circles, joining Toastmasters)

Insights from Damodaran on Corporate Finance-II

Source:-http://people.stern.nyu.edu/adamodar/pdfiles/cf2E/mgtobj.pdf  of Damodaran. 
Aswath Damodaran(Professor at Stern School at Business) is a famous authority on valuation and corporate finance. His website reflects the richness of his practical experience, command on theory and research expertise(he's one of the few academics who uses real world data exceptionally well as his valuations of Groupon/Linkedlin etc show on this blog). Anyways, enough on him, this post reproduces a few highlights of corporate finance, which are quite insightful.Earlier, I blogged on some other insights(http://financeandcapitalmarkets.blogspot.com/2012/02/corporate-finance-some-complied-loose.html) which readers may find useful

1. The above 2 diagrams depict the contrast between the ideal world and the real world. Most Bschools focus on the ideal world but it is the diagram on right which we should care about. The above 3 diagrams themselves can summarize tomes of corporate governance books/laws.
2. The need for debt covenants -stockholders maximize their wealth at the expense of bondholders
1. • Increasing dividends significantly: When firms pay cash out as dividends,lenders to the firm are hurt and stockholders may be helped. This is because the firm becomes riskier without the cash.
2. • Taking riskier projects than those agreed to at the outset: Lenders base interest rates on their perceptions of how risky a firm’s investments are. If stockholders then take on riskier investments, lenders will be hurt.
3. • Borrowing more on the same assets: If lenders do not protect themselves,
   a firm can borrow more money and make all existing lenders worse off
3. Markets are not as shortsighted as they are claimed to be-There are hundreds of start-up and small firms, with no earnings expected in the near future, that raise money on financial markets
   If the evidence suggests anything, it is that markets do not value current earnings and cashflows enough and value future earnings and cashflows too much.The market response to Investment Announcements of research and development and investment expenditure is generally positive 
4. Corporate cross holdings-alternate corporate governance in Germany, Japan, India-At their best, the most efficient firms in the group work at bringing the less efficient  firms up to par. They provide a corporate welfare system that makes for a more stable corporate structure.At their worst, the least efficient and poorly run firms in the group pull down the most efficient and best run firms down. The nature of the cross holdings makes its very difficult for outsiders (including
   investors in these firms) to figure out how well or badly the group is doing. In my personal view, this is a reason for conglomerate discount or premium depending on how the group does..