Typically, we can expect Consolidated revenues to be more or equal to than the standalone revenues, however the reverse can also be true. ITs a rare event but can be observed in a few companies listed in India.
Case Study: Prabhat Dairy
An interesting case study to take a look at would be Prabhat Dairy where Q1 FY19 Standalone revenues (433 Cr) are more than Q1 FY19 Consolidated revenues! (385 Cr). Something which can baffle an analyst at an early stage only to realise later that Inter-related party transactions are playing the magic! Let’s understand how.
Standalone Q1 FY19 results:
Consolidated Q1 FY19 results:
Prabhat Dairy (Parent company) procures and supplies milk to its subsidiary Sunfresh Agro. Sunfresh Agro processes it into processed dairy products and sells some of it back to the parent company (which eventually sells it externally). Let’s take a dummy example to see how this works
Please note: in this dummy example we assumed that Sunfresh Agro sells everything to Prabhat dairy, however, that's not true, it does sell quite a lot of processed dairy products to external customers as well, however for illustration purpose and to ensure readers grasp this concept in a simple manner, for now we ignored that aspect. Presence of external customers for Sunfresh narrows this gap between Consolidated and Standalone figures.
Same was also confirmed in the conference call discussion.
In all the related party transaction examples we have taken so far, we were only dealing with subsidiaries, however, not all related parties are subsidiaries!
Accounting standards have mandated companies to disclose transactions with parties where, directly or indirectly the management of the parent company has ownership/ influence to ensure the conflict of interest of the management of the firm is well disclosed to the owners of the firm.
It's a really important forensic perspective which an analyst can cover to understand how much of revenue is being generated from a related party transaction which isn't an associate/ subsidiary/ JV. Often, promoters with dirty intentions have been known to move money from listed companies to their private (solely owned companies) to benefit at the cost of common shareholders/ minority shareholders.
To speak in context of revenue, how this would work is that the promoter (often majority shareholder/CEO/ Chairman), sells final products of the listed company, at a much cheaper price to his/her owned entity which eventually sells it outside at a much higher price, thereby starving off the publicly listed company’s shareholders of that excess profit which moves directly to the privately owned company’s books.
This might also work in case of raw materials, where purchases of raw materials are being made at excessively high price from promoter owned entities, once again moving publicly owned company’s profits to promotor owned entities.
This is precisely why an analyst should pay extremely close attention to the related party transactions footnote of both Standalone and Consolidated (number usually around 30-40 in the annual report).
Please note: Related party transactions, especially sales made to promotor owned entities/ purchases made from promotor owned entities are not always bad. So, an analyst should not try to corner data points to confirm what they wish it to be rather, focus on what it is and why? Easier said than done, but at least one should try and question everything and corroborate through multiple sources before making any hasty conclusions.
Please read our next blog 111 - Analysing Source of Revenue Part 5 on a similar line as discussed above where although promoter private entities are involved to a great extent in related party transactions it is not such a big cause of worry.