Changing valuation multiples of India Inc

With a big ongoing switch to Ind-AS accounting norms, there will be alterations very shortly in the price to book, price to sales and other such ratios

Come the June quarter results season and 350-plus non-finance companies having a net worth upwards of Rs 500 crore in the BSE 500 universe will switch to Indian Accounting Standards (Ind-AS). Some of these companies were till now following what is termed Indian Generally Accepted Accounting Principles (Indian GAAP). Ind-AS has been formulated by the Accounting Standards Board and notified by the government; they are designed to be similar to International Financial Reporting Standards (IFRS). The aim of the switch, the schedule for which had been announced quite a while earlier, is to bring our accounting norms in line with global practices.

All financial services and banking companies need to shift to the new accounting norms by 2018-19.

For the coming June quarter numbers, as mentioned earlier, around 350 of the top 500 listed companies on the BSE stock exchange would have switched. Analysts believe this could mean a rise in their reported revenues by four to five per cent. While their Ebitda — earnings before interest, depreciation, tax and amortisation — could fall by two to three per cent. The return on equity ratio, thus, could decline by 40-50 basis points after the transition. In sum, the new norms will impact the net worth, return ratios and earnings of Indian companies. And, a significant change in the accounting of mergers and acquisitions, revenue recognition, employee stock options, foreign currency transactions and treatment of redeemable preference shares as debt versus earlier equity, among others.

So, as the reported numbers will look different, it will also have some rub-off on valuation ratios such as price to book (P/B), EV (enterprise value) to Ebitda and price to sales, assuming price remains constant. “(These) Multiples for telecom, especially Bharti Infratel, will be adversely impacted. Those for oil & gas (companies), Coal India and Bharat heavy Electricals will look somewhat better. Arvind’s EV/Ebitda multiple will look higher as the Tommy joint venture will be excluded. Consumer companies’ price-to-sales multiples will look a little lower (as sales increase) but P/B multiples are expected to be 14-15 per cent down,” write analysts at Credit Suisse in a recent report.

Tata Steel and JSW Steel will start to look better on a price to book value metric, due to the higher net worth, adds the report. Investors, thus, need to adjust for these when they look at fair values for different stocks.

As many adjustments will be made to equity value (based on fair value rather than cost), the book value of most companies will change meaningfully. Book value per share is calculated by dividing total shareholder funds (equity plus reserves), net of preferred equity, by the total of shares (minus those not issued). In simple terms, the amount of money the holder of a common share would get if a company were to liquidate.

Analysts at ICICI Securities, led by Ravi Sundar Muthukrishnan, also believe that after the Ind-AS adoption, price to book and price to sales ratios of most companies will reduce. Overall, the Ind-AS mechanism, which is based on fair value accounting, will bring Indian companies’ accounting at par with that of their global peers, enabling better comparison of financial performance with global counterparts.

Analysts say the shift will also lead to increased transparency, led by higher disclosure. And, and more important, realistic financials. ICICI Securities’ analysts note that financial assets and liabilities will be measured at fair value, rather than historical cost.

Broadly, the move will be positive for investors and shareholders in the longer run, even as it will have some impact on reported numbers and valuation ratios of companies. Since the change will be induced by a change in accounting norms rather than the companies’ performance or fundamentals, the market should also hopefully take it in a positive stride.