Tuesday, July 5, 2011

Neyveli Lignite Corp NLC - Fraud allegation - Earnings Quality Check vs NTPC

On 5th July 2011, during market hours , news channels started flashing news of fraud charges in Neyveli Lignite Corp or NLC. It is India`s 2nd largest public sector (PSU) power utility cum lignite mines company.
News here
Stock reacted immediately downwards by falling 3% from 104 to 100 but closed the day in green at 103. So I decided to use my simple ratio check for earnings quality rating ( posted here ) .
Summary  of this post-  investors should not give the benefit of doubt to Neyveli Lignite here and exit. It can prove to be expensive as numbers check raises more questions than give out answers.
Some qualitative check :- To summarize, the allegation is by the Workers Union President and they allege misappropriation of funds to the tune of Rs.10,000 crore and manipulation and cooking up of NLC balance sheet.
Management response -
  1. " This is an attempt by workers' union is an attempt to defame the state-run company".( my qn - Why should workers want to defame their own company that they have been working for years ?)
  2. "'We are following the accounting practices of power major NTPC. Our accounts have been audited internally and by Comptroller and Auditor General (CAG). None of them have raised any objections."( my qn - I did a earnings quality comparison with NTPC and NLC is NO WHERE close to NTPC. Yes, in cases such as Satyam /Enron also no one raised objections )
  3. "The statement that there has been misappropriation of funds to the tune of Rs.10,000 crore and the alleged manipulation and cooking up of NLC balance sheet is totally baseless and made on malafide intention.The complainant is taking only portions of the balance sheet to show a deficit of Rs.10,000 crore." ( my qn - Yes , workers understanding of Balance Sheet accounting could be questioned but most people ,if they spend a decent time at a place are smart enough to know if something wrong is going on. And even a balance sheet expert /analyst also cannot dig out a fraud that easily.) 
Lets try to connecting some dots of the past events -
  • 16 March 2011 - CBI conducts raid on REC (Rural Electricity Corporation) chairman`s house. Neyveli lignite has borrowed Rs 3,500 Crore in the recent past from REC. Raid details here
  • Next day -17 Mar 2011Neyveli mentioned on CNBC channel to Udayan that they are raising Rs 3,500 crores loan from PSU banks ( BoB) from earlier lender REC Rural Electricity Corporation. Text interview here and Video Interview here
  • 23 March 2011 -- CBI raids Neyveli . Details here 
Ok now lets get to the point and see what the hard numbers tell us.
I did the similar ratio check as mentioned in the previous post . Ratio of P and L based Net Income to Cash flow based Profit and P and L based EBITDA to cash based EBITDA.
This ratio would be compared over the years and within the same sector ( here NTPC).
FY11 Annual report for both firms are not yet out so no FY11 data.
Only Consolidated numbers are taken.
It seems for FY08 and FY07 NLC has not given any Consolidated numbers in the Annual report. So numbers for these years might be different than numbers from FY10 and FY09.

Now there are ~ four main worrying signals.( refer table in the end for details)
  1. NI/CFO ratio  for Neyveli Lignite NLC is 7.3x for FY10 vs NTPC`s 1x. This is touching the fan. In Satyam`s case the ratio was ~2x. Another way to interpret this is as compared to the reported PE of 13x for NLC, its actual PE based on Cash flow is 7.3 x 13 = 95x
  2. EBITDA to Cash EBITDA ratio for NLC is 2.3x  vs 1x for NTPC and 3.5x for Satyam
  3. For Neyveli Lignite NLC , in the past 3 years since FY07 ( to FY10) , reported Profits have doubled but Cash flow based profits have halved.
  4. Interest ( in P&L) as percentage of total debt is abnormally low for NLC - 0.8% vs 4.8% for NTPC. Thus NLC barely recognizes Interest cost in P&L.
  5. This can also be seen in row 10 where Cash taxes rate as percentage of Cash before I.T in FY10 and FY09 has doubled to 45% vs 20% for NTPC.
  • Conclusion -So its best to exit / stay away from this stock. It might correct 40%-50% to 50-70 zone.Technically, it has slight short term support at 95 but in longer term it is weak with trading below 200 DMA of 123.
  • Click to enlarge

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