Saturday, November 9, 2013

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.

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 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 +