While analyzing revenue figures one should also look at customer wise revenue. This is to check if there is any single customer/ buyer who is buying your product heavily (as a % of your total sales). If yes, then it reflects that your company might be dependent on that buyer (Not a red flag but an angle which an analyst should keep in mind). There is a mandate in AS-17 that a company needs to disclose their major customers (Sales > 10%) shown in the snapshot below.
Now let us look at one listed company example how they have disclosed their major customers in their Annual report.
Case Study: Suven Pharma
Source: Suven Pharma AR 2020,2021
The company generates almost 30% of its topline from a single buyer. Bayer AG is missing in the top customers list for 2021, however this does not imply that they are no longer the customers of the business, but their % sales contribution has fallen below 10% making it optional for the company to disclose information about them and the company may have chosen not to.
It is often considered a good practice when a company has numerous diversified buyers across multiple industries and is not dependent on any of the single buyer reducing concentration risk of the business.
Not always, but huge concentration at a customer level may pose a significant risk to the business, given customers’ significant influence on the business practice.
Customer concentration also depends on Structure of the industry.
Case Study: PI Industries
In some industries you are bound to have customer concentration as the customers themselves are limited. Think about Agrochemical CSM Industries in which companies like PI Industry supply agrochemical APIs & formulations to global formulators. Now global formulators are limited in numbers with 18-19 major players globally out of which top 5 global players account for the majority of the world market. Hence, PI industries is bound to have high customer concentration to these 5 players. Sometimes it’s the structure of the industry that leads to customer concentration. Hence, directly jumping to the conclusion that high customer concentration is a risk may not be the right judgment to make.
Importance and Details around Long Term Contracts
An analyst needs to check if there’s any long term contract between the customer and the company. A contract is an agreement between two or more parties that creates enforceable rights and obligations. Contracts can be written, oral or implied by an entity’s customary business practices. Checking the nature of these contracts helps us gauge the obligations and potential rewards upon completion of certain milestones. Studying these contracts also help us judge our flexibility and downsides if things go south on the contractual agreement.
Moreover, also take a look at the fact, how the company will cater to the contract requirements, is there any specific plant which they are going to use/ create. What would be the nature of that plant? Can it manufacture only contract specific product manufacturing? Or is it a multi-product/multi-purpose plant?
We have taken a few case studies for you to take a look at on how to go about analysing these contracts.
Case Study: Aarti Industries
Aarti Industries is engaged in 3 long term contracts shown in the snapshot below.
Source: Aarti Industries AR-20.
Upon taking a look at the nature of the plants, they are multi purpose, multi products plants with no risk involved. This has helped Aarti Industries keep themselves in a pretty flexible position despite having engaged in 3 long term contracts.
Source: Aarti Industries AR20, AR21
In FY21, one of the contracts which Aarti Industries had engaged in (FY2018) got cancelled, upon receiving a termination notice from the customer, however as per the terms of the contract, they are still liable to be paid the shortfall fees protecting the firm from the downside.
Source: Aarti Industries AR-21
Case Study: Transpek Industries
Another example is Transpek Industries, where they had established a multipurpose and multiproduct plant to cater to a long-term contract they had engaged themselves with a customer.
Source: Transpek Industries, Investor presentation Sept-2020
The nature of the contract can be found either in Annual Report/investor presentations/ concall discussions & Credit Rating Reports.
In case of Transpek, our Alumni Ahmed Madha, presently working at Unifi capital asked a question around the same in the concall. Apparently, Transpek has engaged themselves in a Take or Pay kind of contract where, even if the customer cancels the contract or they are unable to sell it eventually, irrespectively, Transpek is liable to get the payment. So this contract is a win-win situation for the firm as it is establishing a plant which is multipurpose and multiproduct, so even if the customer cancels on the contract, the firm gets paid and can still use the plant for other products or other purposes!
Source: Concall Transcript, Transpek Industries Q3, FY21.
Case Study: JHS Svendgaard Laboratories
Now, Imagine a company who has established an exclusive plant for specialised products to cater to a contract has hedged itself with due terms, however still the customer leaves/ violates the contract. That's a double whammy for shareholders as the company has not only invested into a dead asset and now will also be stuck in litigation processes which are known to be painstakingly long!
Let's take an example of the same. An Indian Listed company named “JHS Svendgaard Laboratories” entered into a contract with Procter & Gamble, India to manufacture and sell the products which P&G required from JHS Svendgaard laboratories. Below is the snapshot of JHS 'annual report explaining the contract with P&G.
AR-2010 JHS Svendgaard
P&G had become a 50% revenue contributor for JHS! But due to some reasons the contract wasn't renewed/ terminated by P&G so the plants which JHS were using for the contract were suddenly of no use! Below is the snapshot from JHS AR explaining the scenario.
AR-2015 JHS Svendgaard
This litigation was settled outside the court for an amount of 206 Cr paid by P&G to JHS.
(More on this: https://www.bloombergquint.com/markets/jhs-svendgaard-gains-after-settling-dispute-with-pandg )Having a multipurpose plant could have helped JHS, however when you are getting 50% of revenue from one customer, it is bound to happen that you may get cornered into exclusivity clauses in your contract and not cater to any other products or industry for the prospects of growth future may hold if the contract were to stay intact. Precisely what happened with JHS.
From the above example it's evidently clear that JHS’s future growth path was completely hinged on P&G’s contract and with that going south, so did its own trajectory. Analysing Customer wise revenues gives us a very good idea of which industry/ industries your company is catering to. Since your Revenues are directly linked to the demand of these customers, prospective revenue growth of a company's industry would be directly connected to growth of Customer’s industry. If the customers’ industry sees huge growth prospects, it will drive the company’s business along with its momentum. However this tag along process, only works if the contract remains intact and both parties stay true to their path, else, may follow a long tedious litigation process which is a double edged sword and could hurt any one of them!
Please read our next blog 113 - Analysing sources of Revenue part 7 for understanding segment wise and Other Income sources of revenue generation.