Sunday, April 22, 2012

Kudos Infy - You have the right Strategy, but Innovation is the Key

"High Growth comes from balance, you will see us moving towards growth and profitability with the balanced approach that we have adopted"  these were the words of Mr.SD Shibulal after the Q4-2012 quarterly results were announced on 13th the Friday.  These words summarizes what Infosys "stands for" and "will stand for" the years to come.  Right from the days of NRN, Infy never chased volumes at the cost of profits, they were ready to sacrifice volumes if there were no profits.  This strategy has worked for them for the past 30 years and will work for them for years to come.  True after announcement of results analysts battered Infy, stock prices of Infy crashed by a double digit percentage, but the legend lives strong on its principle of growth with profitability.  

Infy has a clear strategy of superior financial growth and strong margins and they have stayed with it.  Let us look at numbers of Infy and other major IT players to understand the strategy of Infy vis-a-vis others.  As now is the trend to look at quarterly numbers let us also look at the "Q" numbers.
                                  NYA - Not yet announced
The analysts are right definitely Infy's revenue growth is under test compared to its peers, growing slowly over the quarters @ 4.6% lowest among its competing colleagues.  Does this mean that the magic of Infosys has waned away?  We have only seen one parameter of the strategy which is growth, let us look at the other parameter Margin.

Here Infy & TCS win hands down, margin @ around 40's where as others are in 20's.  Clearly Infy is living up with its strategy of growth and profitability.  Is it a good strategy to have?  Definitely yes because of the following reasons :

  1. Avoiding Cost Sensitive Clients - This strategy means not working with highly cost conscious clients, whose primary aim is cost and second comes the product.  If there is a price upward revision these clients simply dump the existing vendor and move to another who offers lower cost - No Loyalty 
  2. No Cross Subsidization - Infy looks for profit in every business / client.  This is a very good option, some companies will look at taking clients at very low margin because of volume with the belief that from some other clients they will get higher margins. This is cross subsidy.  Margins will be under severe threat when the higher margin clients exert price pressure 
  3. Falling Quality Standards -  In the long run with margins dropping there will be pressure from investors to keep profitability at reasonable levels.  At that point reaching to customers with price revisions may not be possible, which means cutting costs and some times at the cost of quality 
  4. Increase in working Capital -  Companies with lower margins tend to have higher working capital requirements, as over a period of time their margins will be inadequate to cover Receivables & expenses.  This is turn would mean requirement for working capital and its related costs
  5. Spreading Too Thin -  With volumes increasing constantly at the cost of margin, companies will like to make optimal (high) usage of resources meaning expectations of higher productivity from the existing assets (including Human Resources).  This will over a period of time lead to "Over Utilisation" of capacity and consequent costs related to it will occur
  6. Price Pressure from Clients -  During difficult times like Euro Crises, clients will definitely like to cut their spends in whatever form and the first cut will happen in services, which means IT.  At that point if the margin is reasonably high then a small cut in margin will not affect the company's cashflow and once things are back to normal the margins can be restored.  But on the contrary if margins are low then taking a cut in margin will be very difficult as it would mean (at times) borrowing of funds to meet working capital expenses which will also add to profitability woes.
  7. High Investment -  High volume of business means requirement for higher investments in infrastructure.  Cost of maintaining this infrastructure should also be added to this.  When margins are thin this will be definitely a strain on business funds over a long period of time
  8. More Work less money - Though Revenue  per employee / asset will be higher in companies with lower margin high growth, Profitability per employee / asset will be lower, meaning "More Work, Less Money".  Again in long run this will have its own impact
In the long run definitely the strategy of Infy will be very solid - Growth with Profitability.  But the million Dollar question is how do they achieve both?  This is where I admire companies like Microsoft & Apple.  Both of them rely on innovation.  I like the words of Bill Gates who once said "For me a product is obsolete once it is launched", which means as soon as he launches a new version he considers it to be obsolete and goes back to the drawing board to innovate and launch new products.  Apple with its "i" range of innovative products has taken the market by storm and it not only grows leaps and bounds but also its profitability is sky rocketing.  For information Apple's Gross Margin is in the 40s and Microsoft's Gross Margin is in the whopping 60s.

In short, if Infy has to maintain its strategy as well be a darling to its stake holders it should Innovate.  It should roll out more and more innovative products and price them at a premium and earn higher margins.  One aspect always surprises me is that Infy (and most of the Indian IT companies) are excellent in rolling out SAP by being partners of SAP, but no one has ever tried to create a product like SAP and successfully roll it out (though some have smaller versions of it)?  This is where Indian IT companies have to innovate.  

My advice - Infy turn to the drawing board invest in R&D, roll out innovative products and then surely you can walk your talk of Growth with Profitability, if not you will only provide lip service to your strategy and see your competitive colleagues zip past you.

Saturday, April 14, 2012

What Went Wrong @ Kingfisher Airlines - An Accountants Perspective

It was during good times (or deemed good times?) of Kingfisher airlines about 3 years ago, I took a Kingfisher flight from Delhi to Lucknow.  It was a 40 minute flight.  The aircraft was a big one (not sure of the make), with 6 seats in a row and it had live television on every seat.  Once the aircraft took off the hostess hurried with snacks and believe me it was so huge that by the time I could finish half of it the plane was about to land and the hostess came back asking for the plates, so being typical Indian I packed the left out snack in a tissue paper and continued eating and the hostess happily took away my empty plate.  Though Immersed onto the live television and the snack provided, I also looked around the aircraft and found it was half empty (or half full to be optimistic).  In Lucknow I had one of my colleagues waiting for me to take me to Kanpur and I said to him "for the money I paid, it is too big a service I got from KFA, I am not sure whether they can continue like this for long?"  From that time, being an accountant I kept asking myself how does KFA keeps rolling out these big services at the same time keeping the price tag lower to match its competitive colleagues. 
Now that the tide has changed on KFA and my fear over the years have become real.  The company has been subsidizing its services over the years and the bill for this subsidy was picked by the banks to an extent of Rs.7,200 crores.  Am I right in saying subsidy?  Let me check the cashflow of KFA.


The analysis of cashflow shows that majority of the Cash realised from financing activities over the years have been consumed to finance the loss in cash from operations, rather than taking the money to investment activities.  Argument may be placed that the cash spent on operations is towards working capital but if we look at Net Profit it is negative through out which means expenses outsmarted income by a huge margin.   And according to me it is subsidy.

But did KFA had a choice as this is the state of the industry with high cost of wages due to lack of skilled pilots, increasing aviation fuel cost, congestion at airports leading to delays and consequent costs, compulsion to operate in some routes & intense competition from other airlines.

Let us analyse some more facts.  First, Indian aviation traffic increased 19% CAGR during the period 2006-11, Second, Indian air travel penetration is approximately 0.1 or less trips per year per person this is compared to China which is 0.2 trips per person per year and 2 trips per person per year in United States.  Does this fact suggest something juicy?  Yes it does there is lot of meat to chew, a huge potential to tap.  That I believe is what made KFA over leverage on their finances (ie) spend more than their means. 

Can this huge market availability turn into opportunity for the airlines?  I have my doubts.  First for an airline to make profits there should be world class infrastructure.  I for one believe that our airport infrastructure is far from satisfactory except for some airports in the metros.  This lack of infrastructure will make operational costs higher.  Second, passenger traffic grew 16% CAGR between 2006-11 will that be maintained is quite doubtful atleast in the short term of 3 years as Indian economy is not growing at the speed which it grew in the last decade and there will be a dent in growth rates.  Third most of Airline companies in India have major portion of their revenue from domestic operations which is highly price sensitive, they should tap more into International routes to have better realisation's.   Fourth pricing should be aggressive no doubt to keep competition at bay but it should be done smartly to have expenses covered.

If I were to be CFO of an airlines company what I will do?  It is easy to buy / lease aircrafts as they are sourced out of developed countries and the financial products in India are aped from developed countries and so financing them is also easy.  But the Big Question is "Is the Indian market ready", the answer is NO.  The current Indian market though looks big in potential is a small market and highly price sensitive.  I will look for the long term and a steady growth.  I would not put too much money in too many planes but start modestly, price aggressively (to keep my expenses covered) generate margins, generate net worth and use this positive networth to grow over a period of time (remember our childhood story of Hare & the Tortoise).

KFA is now having a huge negative Networth (BIFR?) they need more money to provide more subsidy to the passengers or alteast pay back the bankers who till now are subsidising.  I would suggest KFA to cut planes / routes, bring in more capital, pay off huge debts, stop major chunk of financial lease, recreate the brand of KFA, generate profits and use that profit to leverage in the long run.

My advise as an Accountant : Indian aviation industry will be a success story, but the players in this industry need to progress with caution as there are too many "Smoke and mirrors" there and it is easy to get foxed into them.  Price your product aggressively but never lose your focus on margins, because once you let it go it is difficult to get it back.   I always say it is good to lose some "Battles" but  win the "War".

Monday, April 2, 2012

194LLA - TDS on purchase of immovable property

From 1.10.2012, if you are buying property more than Rs.50 lacs in urban areas or Rs.20 lacs in other areas be prepared to deduct income tax @ 1% and remit the same to Income tax authorities.  This is one more tax procedure proposed to be introduced to be complied by the buyer of property.

Effective 1st October, 2012 a new section is proposed to be introduced in Income Tax Act, 1961 - 194LLA under which, TDS (Tax deduction at Source) should be deducted at the rate of 1% on all payments made for transfer of property other than agricultural land if the value of the property exceed Rs.50 lacs in urban areas and Rs.20 lacs if the property is situated in any other areas.

The buyer has to produce to the registrar the tax payment challan equivalent to 1% of the transaction value to get the land registered.  This the Government claims will help rein in information on real estate transactions immediately and will help Government curb black money as the Government feels real estate is a major area which generates black money.

Question is will this new levy help achieve the Government objective of curbing black money?  The problem with India is we are extremely good in drafting laws, debating them and enacting them.  But the major point is whether we are implementing the law as it should be implemented?  The answer is a big no!!  What is the Government doing with the data it gets from banks / registrars on large value transactions?  This TDS is more of a duplication of information to the Government.  This new TDS section will unnecessarily complicate the already complex tax laws we have in our country.

"Come on India" let us move forward with tax reforms these type of tinkering legislations lead to a vicious circle leading us nowhere.  Let us not waste time discussing and implementing 194LLA, but spend that time trying to implement GST / DTA and other landmark legislations

Cheques / DD valid only for 3 months from 1.4.2012

From yesterday 1.4.2012 banks will not honour cheques / Demand Drafts which are more than 3 months.   So please ensure that your cheques / DDs are presented for clearing within 3 months.
This follows Reserve Bank of India has issued directions vide RBI/2011-12/251 - DBOD.AML BC.No.47/14.01.001/2011-12, under which it has directed banks from 1st April 2012, not to honour cheques / Drafts / Pay Orders / Banker’s Cheques which are more than 3 months old as against the current practice of 6 months.

Sunday, April 1, 2012

Budget 2012 - Direct Taxes

This article provides a brief overview of budget proposals 2012 and its implications. 

Individual Tax Payers

Basic exemption limit extended by Rs.20,000 to Rs.2,00,000.  For women exemption limit extended by Rs.10,000 to Rs.2,00,000.  No increase for senior citizens to remain at Rs.2,50,000.

Tax slabs have been slightly changed to extend the rate of 20% upto Rs.10 lacs.  The revised rate slab is as follows.

           Upto Rs.2,00,000 - Nil
           Rs.2,00,001 to Rs.5,00,000 - 10%
           Rs.5,00,001 to Rs.10,00,000 - 20%
           Rs.10,00,001 and above - 30%

80C - There is no change 

80D - In addition to the current benefits expense upto to Rs.5,000 on Medical Preventive Health check-up is allowed

80DDB - Senior Citizen age reduced to 60 years from current definition of 65 years

80TTA - Interest received from Savings Bank Account exempt upto a value of Rs.10,000

A new condition has been introduced in 80C as regards insurance premium.  Deduction under section 80C for insurance is allowed only to an extent of 10% of the capital sum assured.

Section 80CCF - infrastructure bond has been withdrawn from tax deduction

Corporate Tax Payers

No change in corporate rate of 30% for domestic companies and 40% for foreign companies. 

No change in Dividend Distribution tax (DDT) rates, remains @ 15% + 7.5% surcharge + 3% Cess (effective rate 16.60875%)

No change in MAT rate of 18.5%

Section 115JC - AMT (Alternate Minimum Tax) of 18.5% applicable to a person other than a company.