Tuesday, February 28, 2012
Rule 46A in AS-11
Q3FY12 numbers of India Inc were not as bad as expected. They were not good but yet, not exactly the washout one had expected. And the credit for this goes mostly to MTM once again, which thanks to the Govt rule coming in at the nick of time 'managed' to paint a better looking picture.
Earlier, till Q2, companies had to necessarily mark-to-mark the loss incurred on the various forex transactions, be it loans or hedging or complex derivative instruments. But in Q3, just before the quarter was coming to an end, a new rule was passed, Rule 46A in AS-11, wherein a company could either transfer the MTM loss to the balance sheet or adjust it against the P&L account. If the forex loan was for acquiring a fixed asset, it was allowed to capitalize the difference, meaning MTM loss arising could be added to the cost of the fixed asset in the balance sheet. This meant no pressure on the profitability. And if the forex loan was for not acquiring a fixed asset, it has given the facility to either create a special account where gains and losses could be adjusted or else, companies could write off the MTM loss in P&L account in same quarter or defer the MTM and amortise it over the borrowing period. Thus major 'hits' to the bottomline were thus averted.
Given the way in which the rupee had tumbled down and then climbed back, certain amount of flexibility was indeed required for adjusting the MTM losses. But it also means that companies were allowed to brush their losses, even though it was only notional, under the carpets. This meant companies 'managed' to show a better performance than what could have actually been. Being notional, could say that this flexibility helped present a better picture and not the distorted one. As such interest costs have eaten margins and this would have dented the margins even more, like in Q2.
In Q2, companies which were impacted by MTM were Tata Motors, Mahindra & Mahindra, Bharti, Exide, SterliteInds, Dish TV, Essar Oil, Arvind, Jet, Sesa Goa, Subex, JSW Steel, Shree Renuka, PFC, JSW Energy; around 70 major companies reported forex losses. Companies like Reliance Communications, Indian Oil , BPCL, JSW Steel , Bhushan Steel, Lupin, Aban Offshore, IOC, Chambal, SAIL and NTPC have forex debt which is around 18 to 52% of the total debt. RCom led at 52%. Thus new Rule allowed adjustment to be made in a staggered manner thus we saw some parts of its trailing in Q3 also.
The picture will change in Q4 as the rupee has appreciated dramatically. From an all-time closing low of 54.30 v/s US$ in Dec 2011, the rupee is now hovering around Rs.49.50, an appreciation of 10% in 2012 so far. Thus do not be surprised to see companies post forex gains in Q4. Forex losses will be there but will be trimmed down from Q2 levels. Aggregate forex losses have come down in Q3 and will go down further in Q4.
The one big question which comes to mind - should one invest in companies who have showed a better profit due to this MTM adjustment? That would not be a prudent move for the long term. The short term ride would be good but that's about it. It would be best to try and look at the complete earnings of the company. Look at the earning ability pre and post MTM. Best companies are those which have not opted for such 'adjustments' and have continued to follow booking the MTM loss/gain as that is the practice followed by global companies across the world. Remember, companies that have deferred or amortised the losses, will eventually have to show this adjustment some time. They may have been shunted out from the P&L account to the balance sheet but sadly, it will remain there for a long time to come. The stink raised in the P&L could be one time or maybe spread over a few quarters but the rot in the balance sheet will smother you over the long run.
Remove all the window dressings and the adjustments; look at the bare picture like examination of a body in the forensic lab; that will give you the true picture of health of any company.