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Krishnan Thiagarajan

In companies with several divisions, segment reporting helps to estimate growth expectations, assess valuation and provide restructuring signals.

WHAT do companies such as Hindustan Lever, 3M India, Grasim Industries, Larsen and Tourbo, ABB India and Dr. Reddy's Labs, which operate in diverse sectors, have in common?

Their diversified business profile spans almost half a dozen segments. And had segment reporting not been made mandatory, retail investors would have had trouble understanding and analysing their sources of segment-wise revenues, profitability and capital employed.

Without management assistance, it is difficult to evaluate the financial performance of a company with only two divisions. This difficulty multiplies with every extra division in a company. Even if segment reporting fails to provide investors all meaningful information to investors, at the least it offers a useful starting point for questioning the management on trends and challenges in individual segments.

Despite all the limitations (spelt out in the main piece), segment reporting (on a quarterly basis) has helped shareholders, investors and investment analysts ferret out information on:

Sources of profitability: Segment reporting aids in understanding the composition of business, its revenue and profitability drivers along with the capital employed. For instance, without segment reporting, it would be hard to establish which among the four key steel plants of Steel Authority of India contributed to profits in 2002-03 or posted losses in 2001-02. Similarly, Bajaj Auto classified insurance and investments separately from its two-wheeler business. This has facilitated a distinction between the contribution from Bajaj Auto's core business of two-wheelers and its non-core segments.

Valuation of M&A: Evaluating the fair price in a merger or acquisition (M&A) deal would be tricky without segment reporting. Take, for instance, the demerger of the copper business announced by Indo Gulf Corporation in July 2002 and its merger with the aluminium business of Hindalco, its group company. The share swap ratio was fixed at 1:12 (one share of Hindalco for every 12 shares of Indo Gulf ). But for the availability of segment information on copper and fertilisers — the two divisions of Indo Gulf, it would have been difficult to evaluate the fairness of this share swap ratio.

But since the capital employed in the copper business of Indo Gulf was available, it was possible to establish that the share swap was tilted marginally in favour of Indo Gulf.

Restructuring signal: Through segment reporting, it is possible to deduce early signals of restructuring — either demerger or sale of loss-making or stagnating divisions or divisions with low return on capital employed.

For instance, with Grasim Industries consolidating itself with the acquisition of L&T's cement division, it is likely to start thinking in terms of divesting the sponge iron business, which has been bolstered in recent times by the strong demand for steel.

In addition, it may also contemplate spinning off and merging the textiles business, which is currently loss-making (though the losses in 2002-03 were less than in 2001-02) with its group company, Indian Rayon, which has presence in textiles.

Another instance which reiterates this aspect is Crompton Greaves. The company currently has four divisions — power systems, consumer products, industrial systems and Digital Group.

Of these divisions, the Digital Group, which focusses on telecommunications, has shown a deterioration in segment-wise results, with a decline in its revenues by over 25 per cent and sharp drop in profit before interest and tax by 60 per cent in 2002-03 over the previous year.

And in the first quarter ended June 30, 2003, the Digital Group incurred a loss before interest and tax. This unimpressive performance may be an early indication of a possible spin-off of this division. Segment reporting helps capture the need for and timing of such restructuring.

Spotting turnarounds/deterioration: Monitoring divisional performance on a quarterly basis holds the key to spotting turnarounds in companies and, at times, even the deterioration in the financial statements of several companies.

For retail investors, quarterly segment data is probably the best starting point for detecting early signs of pick-up in demand in individual segments of the engineering or construction sector.

And segment data has to span virtually the entire engineering sector, starting from diversified companies such as ABB India and Siemens, to compressor/drilling equipment players such as Atlas Copco or Ingersoll Rand and engine manufacturers such as Cummins India or Hindustan Powerplus.

At the same time, segment data also provide warning signals of deterioration in divisional performance.

For instance, following losses made by the foods division of Hindustan Lever for 2002-03, there were rumours in the market that the company was planning to divest or sell off this division.

Not only was this denied by the management, but these have also been dispelled to a large extent with the strong performance of the foods division in the first quarter ended June 30, 2003.

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