Why increasing business complications are eroding Tata Steel's predictability

Despite this, the management could not answer some queries raised in the December quarter analyst call on the difference in pro forma and actual numbers, considering the several layers related to intergroup adjustments. The management suggested analysts seek clarity on some issues such as on the operation of subsidiaries like Tata Blue Scope, separately after the call.

Signs of volatility

In the first nine months of the current fiscal, the company reported other expenses of close to Rs 37,871 crore, an extraordinarily high amount on a sales turnover of Rs 122,597 crore. The nature of these expenses vary and are not well understood, raising curiosity in the minds of investors and analysts.

Analysts questioned the sudden spurt of about Rs 1,100 crore in the other expenses in the quarter. The result presentation noted Rs 300 crore was on account of forex adjustments but there were no details on the balance. While the management generally has these details handy, they said each of these expense runs into several accounting heads. The absence of such finer details, particularly the inclusion of many one-off expenses, requires investors to base their estimates on a lot of assumptions causing earnings uncertainty.

We analysed the sales and net profits of the company for the past 13 quarters or roughly three fiscals. During this period, the median sales growth fluctuation on a quarter-on-quarter basis was about 5 percent, whereas net profit growth fluctuation ranged from -682  percent to 696 percent. While steel cycle is partly responsible, a lot of this is because of the adjustments that are largely unpredictable and unknown in nature.

Divergence a new normal

Constant inconsistency often leads to estimates not matching reported numbers, sending analysts scrambling to find the missing link. Take the case of the last two quarters. In Q3FY19, the company's net profit was Rs 1,753 crore, a tad lower than the street expectations of Rs 2,200-2,300 crore. But, in Q2FY19, the net profit was Rs 3,013 crore as against the expectations of Rs 1,563 crore. Another factor that points to the inconsistency is the fact that Tata Steel was second in the list of companies that saw the highest earnings upgrades (FY19 earnings) after the Q2FY19 results.

One big cause for this variation is adjustments in the expenditures and incomes. During the quarter ended December 2018, it reported consolidated EBITDA of close to Rs 6,734 crore, whereas the adjusted EBITDA was Rs 7,225 crore, higher by about Rs 490 crore. The notes explain this variation to be on account of “adjusted for fair value changes on account of exchange rate movement on investments in Tata Steel Holdings and revaluation of gain or loss on external or internal company debts or receivables at Tata Steel Global Holdings”

The light at the end of the tunnel

The good news is, on its part, Tata Steel is making efforts to simplify the structure and it has already entered into various agreements to exit south East Asian business as well as transfer its most troubled European business under a JV without any recourse of liability to its standalone operations. While there may be scope for more, this will simplify the structure and the adjustments that are visible today.

Such accounting complexities bring to mind what Charlie Munger, the partner of Warren Buffett once said: “Double-entry bookkeeping was a hell of an invention. And it’s not that hard to understand. But you have to know enough about it to understand its limitations because although accounting is the starting place, it’s only a crude approximation. And it’s not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn’t make it anything you really know.”

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