Big Billion day sale -Gainers and Losers

Flipkart start-up which grew in its formative years under the guidance of a bunch of go-getters from IIT-Delhi created a sensation with the ‘big billion day’ sale on 6 October 2014.

 In eCommerce, your prices have to be better because the consumer has to take a leap of faith in your product.

-Ashton Kutcher, celebrity, investor and entrepreneur

 In September 2013, the e-commerce industry witnessed a revolution. That month, Groupon, a leading online discount provider, was selling onion at the 1999 price of Rs. 9 a kg. The price of onion at that point was approximately Rs. 85 per kg in the retail market. The quantum of sales at 21,000 kg was not big enough to create a stir in the market.

However, the discount mania came to stay in the Indian e- commerce industry. The mania reached its height with the big billion-day sale on 6 October 2014. Flipkart decided to sell goods at impossible prices. The excitement led to confusion and confu-sion led to Flipkart apologising. So the question that arises is who gained from the fiasco.

e-commerce market places

In India, Internet penetration is increasing exponentially. This, many believe could lead to “the rebirth of e-commerce

industry.” However, the onus lies on the e-commerce players to get the netizens to their websites.

Without doubt Big Billion Day has been able to attract reticent consumers to the different e-market places. Snapdeal ran an advertisement on the same day: “For others it’s a Big Day. For us, today is no different.” According to Flipkart’s official numbers the sale for the company was at almost a billion rupees. Hence, the cumulative sales of the two Indian e-commerce market places touched Rs.2 billion. Not to be left behind Amazon used a cost effective strategy for increasing visits to their web-site: they bought the domain name bigbillionday.com. Hence, anyone who typed bigbillionday.com was directed to the Amazon website.

Clearly, the e-commerce market place seems to have gained from the whole exercise especially keeping the gifting season in mind. Sales have not only increased for the big billion day but remained high even after that. The perception cre-ated from the whole exercise is, online buying is cheap.

Customers – loyal and potential

Flipkart customers were unhappy because they hardly could buy anything that day. However, consumer memory is short and the in-cident does not seem to have dissuaded these customers from shopping online at flipkart.com.

It should also be noted that the customers faced the same kind of problem at the time of the launch of Moto -G and there was hardly any hue and cry over it.

Offline market places and traders

It is beyond doubt that this kind of predatory pricing would

kill competition. The worst sufferers would be offline market places and traders. The cost structure of an offline market place does not allow the companies to provide this kind of discounting. Eliminating middlemen helps online companies deliver at lower prices. In the United States a lot of bookstores, notably the popular Borders, closed as they could not compete with Amazon. So what is the way out for these offline com-panies in India? AAP leader Adarsh Shastri, who has spent considerable time at Apple, Samsung and Vodafone, has taken the cudgels on behalf of more than lakh small time mobile phone traders so as to lobby with mobile phone manufactures on protecting the interests of small traders. However, such protectionism might not work in the face of dynamic nature of e-commerce market.

In all probability the line that proactive traditional retailers are expected to take would be to collaborate rather than compete with the online market place. For proof, see the Future Group collaborating with Amazon to sell their products online.

 Regulators

The e-commerce discounting melas are a reminder that e-commerce is a highly unregulated market with very few con-sumer protection mechanism in place.

Like, it is possible that the market place increases the price a day before the discount mela and then provides discounts on the high prices. There is thus the need to have a separate proactive regulator for e-commerce markets as the industry is growing fast and needs hands-on regulations.

The author is Assistant Professor, VJIM Hyderabad.

First published in Industrial Economist, November Edition

July numbers give Jitters INDEX OF INDUSTRIAL PRODUCTION

The IIP July data has taken everyone by surprise. After a robust showing for the last 3 months, there was a dip in IIP index in the month of July. The IIP index fell to 0.5 percent as shown by the
official statistics. It should be noted that June month had shown a growth of 3.9 per cent. The data had been revised upward from 3.4 per cent stated earlier. The growth of the national economies is measured through gross domestic product, which measures performance in manufacturing sector, service sector and agricultural sector. To get a detailed view of how the economy performs one needs to have a bard’s eye view of these sectors which could be interpreted and analyzed through different sets of data. In India the performance of industrial sector is captured with the help of the industrial production index, referred to as IIP or Index of Industrial Production. It is a monthly data that measures the performance of the industrial economy. Hence, the data is used for gauging the growth of the economy in the short run. The base year used for the index is 2004-05. Though it has been changed numerous times in the past, there is a demand to change the base year to 2011-2012.
A fall in IIP numbers indicates that the industrial economy is facing a downturn. Industrial sector data is an important indicator of supply side growth in the economy. The fact that the industrial
sector data shows a meagre growth of 0.5 per cent points to the supply side bottlenecks. In other words, it means supply is not picking up as was expected in the given period.
Capital goods data indicates low investments 

Though July numbers were disappointing, some experts attribute it to the base effect. Notwithstanding, the fall in capital goods segment is really worrisome. The growth in the segment fell from 23 to -3.5 per cent . This figure indicates the total amount spent on buying machinery which augments production. Hence, this figure is indicative of the future expansion plans of the economy. It can thus be used to gauge sentiments of the economy - the direction in which it is moving and why. According to the RBI governor Dr. Raghuram Rajan, the growth of the economy, to a great extent, depends on investment growth. The capital goods figures are indicative of the investment growth. Hence, a fall in the numbers is indicative of the problems the Asia’s third largest economy is facing. The fact that the numbers are below the level in the base year does not help matters either. Hence, efforts are required to improve this number. Many a times high interest rates may dissuade companies from expanding business, which could also be a cause for the fall in July IIP numbers. Another reason could be postponement of investment by many companies, given that several banks are planning to take action against erring corporate borrowers. Given this gloomy scenario, there is a need for bringing in structural changes so as to improve the capital goods expenditure.

Core sector growth muted The core sectors are the most important constituent of the IIP number. They have a weight of 38 per cent in the total IIP index. This quarter the core sector has seen a fall from 7 to 2 per cent. The contraction in the size of its constituents led to the fall. The fall in the infrastructural index also does not augur well for the economy as the economic growth is impacted by infrastructural support provided by the eight industries which form the core sector. However, according to experts and analysts this low growth can be attributed to continuous increase in core sectors such as electricity and steel. It is believed that these sectors could see growth form hereon.
Consumer goods surprise
Consumer goods refer to the goods to be consumed by individuals. Hence, consumer goods
are an important demand side indicator. A fall in consumer goods by 7.4 per cent shows a negative sentiment during the given period. There seems to be fall in both supply and demand side which does not augur well for the economy. This is followed by a fall in consumer durables and non durables too.
Expected reaction by the RBI
RBI is expected to continue maintaining status quo (on interest rate front) and would not like to react to the given situation as these numbers seem to be out of synch with the bigger story. The
GDP numbers of the last quarter as well as the BOP position seems improved. Hence, reacting on these numbers would not make sense. Moreover, the reliability of IIP numbers is also debatable.
Therefore, it is advisable to wait and watch if there is any upward revision in the data.
Government policies and IIP number
It should be noted that the government at present has not made any structural changes in the economy. However, earnest attempts are being made to iron out bureaucratic inefficiencies in the system. These attempts would take time and hence it is not expected to yield results immediately. Having said that, structural changes are of paramount importance for the development of the economy and efforts should be made to increase the efficiency and efficacy of the
system by bringing more transparency in the system, making policies irreversible and homogenous across states. Also, as the IIP numbers show the short term sentiments, they cannot be used
to judge the long-term sustainability of the policies which have been introduced by the government. Hence this data should not be given too much of importance in terms of long-term growth.
Major challenges faced in improving IIP data
• Consumer Price Index continues its northward journey The wholesale price index is under control. However, price level for consumers keeps increasing persistently. This increase in price levels would stop the RBI from lowering interest rates which, in turn, would impact the investment climate in the country, thus muting future growth prospects as capital goods numbers
would decline.
• Volatility of IIP data 
The IIP data is highly volatile. It keeps on fluctuating regularly. This fluctuation in the value would tender the data unusable. The reliability of the data is also being questioned consistently. The revision of data adds to the woe of decision makers. Hence, it is imperative that steps should be taken to make the data more robust. The long standing demand of converting the base year to 2011- 2012 should also be implemented.
• Supply side bottlenecks
There are supply side and bottlenecks, which have hurt growth for long. To tackle them, the
government is needed to invest heavily.


Going forward, a lot is being expected from the BJP government  at the helm. They need to make sure that the investment increases in the long run. Development without structural changes is not
achievable and the government must go all out to bring in the same.

Note: This article expresses my view on IIP July data released in September published first in Global Analyst October edition.

"Jugaad by Uber, scorned by RBI" - Right or Wrong

India is known for Jugaad and innovation. However, the Indian regulators such as RBI are not known for appreciating the jugaad or innovation by players who innovate.  Uber, a cab company seems to be at the wrong end of the stick. So what happened, and how. 

Uber's Entry into India :

Uber is an online platform that acts as an interface between passengers and taxi drivers. They operate through a smartphone which facilitates internet booking for passenger.
 The company entered India in August 2013 via Bangalore. (more on their entry can be known through the preceding link.) They were already present in around 40 countries.The main reasons for the company to venture in India was fragmented unorganized market and low entry barriers. The market was dominated by few players such as Meru, orange cab, and green cab . The company operates in the high end segment where there are very few players in the country. The cars available on rental include luxury cars such as Mercedes, Audi etc. The company derives strength from huge financial muscle that it derives from investors such as Goldman Sachs, Jeff Bezos (the man behind Amazon) and Google Ventures. 

Major Challenge for Cab Industry in India:

The major challenge for cab industry in India is customers cancellation rate at last minute . This has also lead to strikes at leading companies such as Meru. (Last minute cancellation impacting drivers morale) . Cab Companies have been trying different methods such as allocating pick ups only 20 minutes drive from drivers residence, however these methods cannot work always due to practical challenges. Then entered Uber, taking advantage of a loophole in the system they came with a novel solution. 

Solution through JUGAAD: 

All the payments were to be made online and no cash payments were accepted. It was made through a foreign gateway hence the two step authentication which is mandated by RBI was circumvented. The payments were to be made as soon as the person stepped out and hence the company could now conveniently charge for cancellation of cabs too as payment data was stored in advance. This made both the company and the drivers laugh all the way to the bank. However, it created an uneven playing ground leaving the traditional Indian cab companies complaining about not being able to charge for cancellations.

RBI's Action and Reaction thereafter

RBI has disallowed payments gateways from foreign countries from being used in India.   Thus companies such as Uber are in a fix. There is a lot of hue and cry from supporters of free economy including economists such as Ajay Shah who in his blog entry Uber versus RBI ( http://ajayshahblog.blogspot.in/2014/09/rbi-vs-uber-continued.html )
 has denounced RBI as being dictatorial in it's approach and not helping free economy to function in India. His example of Uber helping save millions because of few minutes saved in payment process appear highly stretched. In India we waste a lot of time due to roads being non existent and public transport system failing. Hence a few minute here and there involved in making payments will not make too much of a difference. On the other hand average speed of internet is surely on the lower side and everyone does not have internet access on their mobiles. Where, technological literacy is low and technology usage is on the higher side as a customer we do expect the regulator to play a proactive role in  protecting our interests.

To add to this India is not the only country where Uber is facing stiff opposition. Even in countries such as Germany and South Korea Uber has run into problems with the authorities. When it comes to payments online I agree it is difficult to make regulations that satisfy everyone. However before making any radical changes to the existing regulations it is important that we are able to regulate based on existing norms. So I do not find anything wrong in the action taken by RBI.

The Way Forward:

The company needs to change their business model going forward if it wants to continue to function in India. According to media reports the company would most probably continue to operate in India however the payment gateway would have to shift to some Indian gateway such as PayTM. This would lead to following the 2 step authentication process which might increase the "waiting time" and hence the inconvenience for the customers.

 I

Will Pro Kabaddi Franchisees make money

Every sports worth the name seems to have a pro league in India which has commenced or will commence soon. These games include cricket, football, hockey badminton and lawn tennis.Now the question that need to be asked is do these leagues just have prestige value or can they make money too for the franchise owner.

 The common wisdom has it that "pro-leagues do not really help create money for the franchisees" but it does help create mileage for  businesses and individuals who are looking for brand name for future. What if there is a popular sport where players are available cheap; the game is exciting and the audience can relate to the team and above all there are brand icons associated to add glitz and glamour to the game. So kabaddi seems to be the answer.

Here are some facts about the pro kabaddi league that would help the game become popular:

1. Audience in India can relate to the game easily as it is a popular game in India.
2. The prokabaddi is fast paced and can be finished in 40 minutes hence it is short and exciting.
3. The space required for the game is lesser compared to other popular games such as cricket and football.It is popular among both men and women hence couples watching matches together would bre more common.
4. Mashaal sports the brain behind pro kabaddi is run by Charu Sharma who understands the sports industry well and Anand Mahindra who is an astute businessman who can monetise these opportunities well.
5. The support of a strong media partner in the form of star sports adds strength to the whole process.
6. The owners of the teams are all brand icons in their own right. This adds to the who process.
7. With a nationalist government at the helm of affairs the government support could also come in if the game attracts the requisite critical mass. 

Following is the business model of kabaddi: :

1. Revenue: The major sources of revenue for the company includes sales of tickets for home matches, sponsorship, memorabilia, share of advertisement revenue and share of  stadium revenue.
• In the first season the major source of revenue was sales of tickets. The last leg saw full house. 
• Revenue from advertisements and sponsorship were on the lower side. this edition. However, going forward with the reach estimated at 218 million it is expected that the revenue from advertisements and sponsorship would increase in the March edition of the event. One fourth of the total viewership could be attributed to age group 15 to 24. Hence, the growth of revenue through advertisements targeted at this age group is expected to increase.
• As the popularity of pro kabaddi increases the icon players could help generate revenue for the game through sales of memorabilia going forward.
2.  Cost: The major cost drivers for pro kabaddi league teams include player acquisition cost, license fees, transportation and lodging costs for players.

• To promote the game the pro kabaddi franchisees have been able to acquire the teams at token price only.
• As the game is not rewarding financially for the players traditionally, the whole team have been bought at INR 60 lakhs. Hence the cost of acquisition is extremely low.
• The other major expense is travelling and lodging cost.

Looking at the low cost structure it can be deduced that the investors in pro kabaddi league can breakeven in a short period. It is estimated that the franchisees will break-even in three months compared to fifteen months in case of the bellwether IPL cricket league. 

Budding Entrepreneurs should not ignore financial feasibility

A lot of us would like to be entrepreneurs given a choice. However, what is that we must know about finance before setting up the business. This is a question which i have been asked many a times from friends, relatives and even co-passengers while travelling. Here, is my attempt at answering the question.

1. Every entrepreneur should know the concept of  risk and return.Newspapers frequently talk about individuals who have invested money and believed in their ideas, and this belief has resulted in profits  unheard of. The counry also is seeing a spurt in young entrepreneurs who have jumped into the fray with nothing but intellectual capital. The question is do all these ideas work. According to Bloomberg, around 80% of businesses that start fail. What does it mean in terms of risk? In simple terms, the risk is high. Hence, even though expected returns are on the higher  side the chances are that getting the returns are low. Same was true for most of the software firms that registered loss in 2014.
2. Profit is a function of revenue and cost. However, good your business idea is if you are not able to earn profits from the business sustaining it in the long run is generally difficult . Being conventional, I would not really look at business idea, which sustain on investments rather than their own internal accruals in medium and long term. Any organisation which has had a life of more than five years should be in black and making profits. The profit can be earned only when revenue is more than cost. If revenue is less than cost for more than five years, for any start up, it should seriously start looking at different avenues of augmenting revenue or controlling cost.
3. Profit is not equal to cash flow from operations - A lot of start ups face challenges in monetizing their idea and generating revenue out of it. Once revenue is generated, the next big challenge is to realize it in terms of cash, especially if you are a start up in the Business to Business (B2B) space. If your business model is such that you make immediate payment to everyone you owe, but it takes time for you to collect money, there are going to be a severe liquidity crunch in the future. Case in the point, is a digital marketing company I know which went bust because the real estate company which owed them INR 20 lakhs defaulted .
4. Revenue is a function of selling price and quantum sold. The main aim of any entrepreneur is to maximize revenue and have sustainability in the long run. However, the same cannot be done until and unless the company understands the value proposition it delivers to the consumer. If the consumer is not satisfied with the value proposition, the revenue cannot be maximized. This is true in the case of a lot of intangible services. Case in the point, is the dabbawallahs of Mumbai. Even though dabbawallahs of Mumbai, was a idea that caught up in Mumbai it did not pick up in other cities. It was because it did not provide the same value proposition to the consumers in other cities. The other factor to be considered is the life of your product. In case of technology intensive products, with disruptive technology becoming the buzz word, sustainability is an issue hence generating sustainable and predictable revenue stream is becoming a challenge.
5. Fixed Cost increases pressure to deliver: Cost can either be categorized as fixed or variable. Fixed Cost does not change with time, while variable cost is proportional to Sales. Hence, if sales are low for a start up and fixed cost is high the pressure to deliver increases and hence the probability of going cashless also increases. An important factor to be kept in mind for any business where salaries is the largest cost driver, is that salaries is a fixed cost. Hence, hiring people who are not required just because you have some idle cash from investors should be strictly avoided. Case in the point is pagalguy.com in education digital space which has only 14 employees whereas most of it's competitors have more than 100 employees.
6. The expected return is always a function of the servicing cost of  raising money for the business. The money for business could be raised from internal accruals (previous years profits), borrowing, preference shares, equity shares, or hybrid instruments comprising two or more instruments.

A finance teacher's view on rail price hike

" The railways can survive only if users pay for availing of facilities." - Arun Jaitley, the finance minister

When the finance minister makes this statement it reminded me of a post from one of my friends from school days who has returned to India after quite some time:

"Having jaw dropping experiences in India every time I go out shopping. Prices of everything have tripled or may be even quadrupled than what it was four years ago. The only solace I have is to convert the prices to USD as opposed to my first trip outside India when I used to convert prices to INR and panic." 

source: Facebook. 

Mortals like me who chose to stay in India do not have the "solace" of converting prices to dollar also. So increase in fares cannot be seen in isolation, we need to look at existing inflation levels and impact of increased rail freight on inflation and growth.

Now being a student and teacher of business models,I know one thing for sure people like to pay a premium only when they are satisfied with the existing services. No one pays premium to support  future infrastructure growth. I have been travelling the length and breadth of the country using railway as a medium of transport extensively for the last two years and these are my observations:

1. Every second person travelling in Ac 2 tier and every person travelling in AC 1 tier does not pay for the service because either he is a railway employee or he is a politician. These are the compartments where the margins are high and elasticity of demand is also high. Imagine if banks starts giving money to employees without claiming it back and only person taking loans meant to be at higher interest rates are bankers who will never return it.
2. The quality of service in trains are pathetic. Toilets are never clean. The staff on the train who is supposed to clean the toilets is only seen at the time of collecting tips. The attendants never give towels unless asked by the passenger because if the towels are lost he needs to pay from his pockets.
3. There are very few trains which run on time especially long distance trains. There is no value for money.
4. Streamlining of operations with a view to reduce cot is more important than increasing prices.

Here is a suggestion I have for the government:

Please understand that if you want to operate as a company you need to appreciate the fact that government is a conglomerate with a number of Strategic business units.In your case, it is not possible to run all the SBU's profitably

The system needs to be streamlined so that corruption is minimized, if not removed. Inflation stems from inability to develop a proper warehousing facility and  from wasteful government expenditure. I am yet to hear of any concrete steps taken by the government in these two areas. I would also like to know if there is any tax payer whose son goes to a state government school 

(I know centre government cannot do much, but then something needs to be done) or he can even imagine being admitted in most of the government hospitals. Please concentrate on these areas it would help improve the standard of living of the country rather than looking at simplistic measures of revenue generation and then using rhetoric to justify a move that does not make sense.

Disclaimer: This is my personal view 

How to analyse news pertaining to companies - part I&II

One of my students asked me how to analyse news on companies. This made me think and here is my honest attempt at creating a framework for analysing news. I would like to break the exercise into three steps in two blog entries. Hence, this blog entry may look incomplete in in itself. However, I would like to give the readers time to internalize the process, as the ability to categorize news depends on their ability to relate to business situations.

This blog entry talks about the first step. 

The first step involves mapping the news with nature of financial activity involved.

There are three basic financial activity that any company is involved in

1.      Raising of money and servicing the money raised - Financial activity

2.      Expenditure which increases future earning capacity and income from selling such asset -  Investment activity

3.      Income and expenditure as aresult of day to day operations is known as operating activities.

When any news is announced if you want to understand the financial implications of it the first step is to categorize the news as financial, investment and operating. Here are few examples,taken from google news:

1.    UK:Cargill eyes UK growth through capacity expansion (please visit the link to know more.) The following news refers to Cargill, an agro-based company expanding it's operations in UK. Any expansion news pertains to investment activity as expansion necessarily mandates investment.

2.    Rolta to raise over $200 mn through overseas bond issue  (please visit the link to know more.) Here, bond is a source of raising funds. Hence, it can be deduced that the company is raising money through bonds. Hence, this news pertains to financing activity. 

3.    Kellogg to cut down jobs by 2017 as part of 'cost-cutting plan'   (please visit the link to know more.)

Salary is an expense which is met on a monthly basis and is recurring in nature. Hence, salary can be treated as an expense relating to operating activity. It should be remembered that operating activities impact profitability directly. 

My advice to all those who are students of business analysis is that you should spend at least a week in slotting news in different categories. 

In the next part we would talk about how every financial activity has an indirect implication on other two activities and how the three are connected.

PART II

How to analyse news pertaining capacity expansion

"India Cements plans to expand its capacity in Rajasthan with the possible investment of around Rs 650-700 crore to cater to increasing demand in Gujarat and Madhya Pradesh" -Source: Business line Feb 14 th ,2013

Investing Angle:

If we look at the news the first thing we realise is that the company is expanding it's operations. So the news relates to investing activity as the company is augmenting it's future earning capacity. Here, we should realize that Rome was not built in a day hence the process of capacity expansion would take more than 1 year. I believe it would take at least 3 years.

Financing Angle:

Now the amount required to expand is INR 650-700 crore. The amount can be raised through the following sources,

·         Internal Accruals:

Internal Accruals refers to the profit that the company has not used over the years. Here the best indicator would be the cash and bank balances.

 If you look at the balance sheet of the company for the years 2012 and 2013  at moneycontrol.com you realize that the company has hardly INR 5 crs. Hence it is not possible for the company to raise the amount through internal accruals. 

·         FPO:

Follow up Public Offer (FPO) refers to the process of raising money from the stock market. 

With Indian economy yet to show signs of growth, the market might have not been receptive to an IPO in and around February.  

·         Debt Instruments

Debt instrument refers to raising funds through borrowings. Borrowing comes with an obligation, in form of interest payments. If the company has huge debt as is the case with India Cements raising further debts will be a herculean task. It could also increase the pressure of performing with an increasing interest rate scenario.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow. Google +

The economics of gifting Cadbury explained

The monetary consideration involved in gifting gives rise to a whole industry that thrives on people gifting each other gifts that have materialistic touch about it. However, hard we may decry the economics and materialism involved in gifting it would be difficult for us not to be happy when we get gifts. We are in the middle of the peak season of gifting. Diwali is around the corner and this is the time when we exchange the maximum gifts in India. India is an important market for the multinational companies as along with Brazil, Russia and China they have captured approximately 45% of the market.  So let us now understand what the big pain point is for these chocolate companies using Cadbury India example

What are the factors we need to look at to estimate the profitability of these companies through sales of chocolates?

·         Total Sales - (Product of Selling Price and Units sold)

o   Ability to increase the selling price of chocolate depends on the responsiveness of change in quantity demand. It is expected that the price of certain high end chocolates such as Cadbury Dairy Milk Silk and Bournville should increase as the demand for these chocolates are inelastic, hence increase in price does not lead to decrease in quantity demanded..

o   The demand (units sold) for chocolates peaks in the seasons when there is festivity. Hence, October to December is the best quarter for the company. The increase in demand might also be attributed to increase in total online gifting.

Cost of Raw Material: As can be seen from the table below raw material as % of sales has increased over the years.

              Table 1 - Cadbury India – Raw Material to Sales

              

Particular (INR Cr.)	Dec 2012	Dec 2011	Dec 2010	Dec 2009	Dec 2008	Dec 2007	Dec 2006
Net Sales	4,065.98	3,364.65	2,503.24	1,934.38	1,588.59	1,293.47	1,058.24
Raw Materials	1,576.33	1,247.80	903.81	617.29	522.06	394.55	295.95
Raw Materials as % of sales	39%	37%	36%	32%	33%	31%	28%

Source: Capitaline

The table above finds the ratio between cost of raw materials and sales for the FY 2006 to 2012. As the cost of raw material to sales has been more than 25% it can be deduced that that cost of raw material is an important cost for the company. The other conclusion that we can arrive at is cost of raw material has been eating into the potential profits as it has increased in proportion from 28% to approximately 40% .

Now the important question is why is cost of raw materials increasing?

The cost of raw materials is increasing primarily because the cost of cocoa which is an important ingredient is going up. The reason why the price of cocoa is going up is that there is a mismatch between demand and supply with demand outstripping supply. Hence, one alternative for manufacturers of chocolate is to reduce cocoa content and increase artificial ingredients. The other alternative is to decrease the size of the chocolate bars and keep the price same. I believe most companies would prefer decreasing the size of the bar rather than impacting the taste of the chocolate.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +

PVR Cinemas sells off Anupam, South Delhi Cineplex and Leases it back - explained

PVR, one of the most popular chains of cineplexes in India has of late sold Anupam, one of it's flagship  cineplex, situated in South Delhi, to an undisclosed party for Rs. 52 cr. This news would have been noticed by all those Delhites who have seen movies at PVR Anupam. However, it is not the selling of Anupam cineplex that has evoked interest from the analyst community. The fact that the buyer has leased back the asset to PVR is what has evinced interest. So what are the financial ramifications of this transaction is the question that I try and explain the readers of the blog. 

Let us see how the financial statements are being impacted by the news. If you are not clear with your financial statements you could just read the paragraph below. If you are a pro just ignore it.

There are three financial statements that companies essentially prepare:

1. Income Statement - Aimed at arriving at the profit the company earns in the given accounting period
2. Balance Sheet - Aimed at calculating the solvency (long term debt paying ability) and liquidity (short term debt paying ability) position of the company as on a given date.
3. Cash Flow Statement - Aimed at arriving at the cash balance at the end of the year. It is divided into three parts cash flow from operations (money generated from operations) , cash flow from investing (money spent on buying assets net of assets sold) and cash flow from financing (money raised for business net of money returned to investors,lenders etc.). 

When cineplex is sold  for Rs. 52 cr. in cash what happens to the financial statement?

Balance Sheet: Operating non current asset (long term asset which help earn revenues) decreases in this case  and cash (which is a part of short term asset increases) . Thus, the company's operating profit generating capacity decreases as it's operating non current asset decreases and hence if we look in isolation the company has contracted in size.  

So here is how the balance sheet would be impacted by the transaction when it comes to PVR Cinemas Ltd.

PVR Fixed Assets (A)	Impact	FY 2013	FY 2012	FY 2011
Gross Block	493.57	545.57	385.37	353.24
Less : Accumulated Depreciation	230.78	181.68	143.60	112.84
Depreciation (As shown in Income Statement)	49.10	42.95	31.36	24.11
Net Block	262.79	363.89	241.77	240.40
Depreciation Rate	9%	11%	9%	9%
Cash (B)	72.63	20.63	12.55	35.12

Source: Capitaline.com, PVR Annual Report 2012,2013

Hence, as can be seen in the table the Net Block of Property, Plant and Equipment will reduce while Cash has increased.

Cash Flow Statement -

• Cash Flow from operations would decrease/ increase depending on the lease agreement
• Lease Expenses would appear as an operating expense; cash flow from operations would decrease.

• Cash Flow from investment would increase as sales of asset would bring in cash.

Income Statement

Operating Profit (EBIT) would also depend on the lease agreement as in the case of 

• Lease Expenses would appear as an operating expense
• Depreciation expenses would decrease by approximatelty Rs. 5.1 cr. (10% of Rs. 52 cr.). Rate of depreciation is based on historic depreciation rate.

Impact on the stock price:

The markets have  reacted favourably to the news as even though technically assets have decreased, the company still reaps the benefit of assets. With decrease in assets, return on asset and asset turnover ratio has improved. The price of the stock has moved up from  Rs. 485 to Rs. Rs. 515 in 3  days of trade.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +