In this post we discuss two more critical angles to analyse revenue sources of the company. Let's start with the importance of analysing trend of Operating Revenue Vs other income of a business.
Operating Vs Non-Operating Revenue/ other income
It's great to have growing revenues for any business. But an analyst needs to check if the growth is sustainable/ coming from core business or from non-core activities? Operating revenue means the revenue which a company generates from its core/ primary business whereas Non Operating revenues would imply non core business (we have discussed this thoroughly in our previous readings). For an analyst it becomes very important to track operating revenue as a % of total revenue. Increasing non operating revenues as a proportion may indicate that business may be deviating from its core operations.
If the proportion of non operating income is increasing for any business, it could be on the back of the fact that the core operations of the business are slowing down due to decline in overall industry/ business. Sometimes, it may also happen that the business does not really require much growth capex in core business, which means re-investment rates might be way too low in such an industry and management simultaneously is not using this capital either for dividend distribution or for expanding into adjacent territories, horizontal or vertical expansion neither entering into some other industries like ITC did from cigarettes to hotels to FMCG to Agri inputs. In such a case, you would notice that cash as a % of the Assets may be increasing on the balance sheet.
While in some industries the inherent nature of business is such that you earn high Free cash flows due to low re-investment rates in business and that leads to cash accumulation even after sufficient dividend distribution. Such a scenario is often visible in AMC industry balance sheets. Sometimes this storage of cash may be also necessary due to future unplanned contractual obligations that may arise. This scenario becomes perfectly suitable for the Life insurance industry.
Example: Jagran Prakashan, you would notice that the revenues have been dropping for these businesses owing to the declining newspaper industry.
Source: ICRA Credit rating report on Hindustan times (Peer)
Another example: Bajaj Auto: Main business is so asset light that it doesn't have scope to invest anywhere, leading to increasing proportion of cash on balance sheet.
Segment wise Revenues
A single part of a business that can be distinctly separated from the company generating either 10% revenue or else should have 10% or more asset/ liability is called a segment. Such segment level revenue analysis can help an analyst get a brief idea about how overall business is driven and individual segment contributions to the same.
ITC is an Indian Listed company which has a diversified presence across industries such as cigarettes, FMCG, hotels, paper and packaging and agribusiness. These types of companies are also known as conglomerates.
A conglomerate is a corporation/ entity that is made up of a number of different, sometimes unrelated businesses. So for an analyst it becomes very important to track segmental revenue growth over the years for this type of business to understand which segment has grown more and which one is contributing most/ least to the overall revenue.
Case Study: ITC
For an Entity, there is a mandate to provide key data points of these segments i.e. segmental revenues, segmental asset/ liabilities, Operating profit and Capex. We would be covering only segmental revenue for now and in our different posts the rest would be covered. Below is the snapshot of ITC providing segmental data in their AR.
Source: ITC AR-21
Let's understand this table. One can see three columns here, External, Inter Segment and Total.
External would imply sales to external customers (outside company) and Inter segment would imply inter department/ segment sales Ex: Agri business makes 4881 Cr sales to the rest of the business segments. These Inter segment sales would cancel each other out when we try to calculate consolidated Revenues (termed as “Eliminations” while consolidating) using the same logic we discussed when we studied Consolidated Vs Standalone.
An analyst can analyse this data in two ways, one would be a common size analysis of revenue to judge contributions of each segment over a period of time and second would be to take a look at the growth rates or CAGR of individual segments to judge which segment has seen best/ worst growth rates over the years.
But One may be confused, on which revenue figures should you take for analysis, External or Total?
It depends, we recommend taking Total revenues if we are trying to judge capital allocation/ operations across segments. There could be segments present in business with the majority of their revenues being generated from inter-segment sales as their major purpose is to cater to other business segments (these are generally called Cost Units and not Revenue Units).
If we take only external revenue, we may end up undermining their contribution to overall operations of the business. However if your purpose is to calculate % of contribution towards firms revenues/ profits, we recommend you take only external Revenue i.e. Revenues generated by selling to outside clients only and NOT the parent company.
Case Study: ITC
We have done a sample analysis for you here. We have calculated the common size % as individual segment revenue/ External revenue of that year.
ITC Segmental Revenue
So if we look at the above data we’ll see that the cigarette segment has been the major contributor to the top line (%wise) and the contribution has been decreasing from 65% to 43% (%wise). This doesn't necessarily imply that Cigarettes revenue is decreasing (though that seems to be the case in the last few years from the YoY growth rates). Some interesting interpretations:
1) Cigarette business seems to be struggling with bad growth rates in the recent past. Upon investigating business reasons from the MD&A commentary, we see issues of excessive taxation, illegal cigarette trades and degrowth in the tobacco industry in recent years.
Source: ITC 2018 AR
The common size contribution of cigarettes segment to entire business revenues is decreasing and this is due to other segments growing relatively faster than the cigarettes segment. Same can be verified from the YoY growth rate figures.
2) FMCG-Others segment seems to be gaining quite a lot of traction. This segment has seen quite a high growth in recent years and their contribution to overall revenues has been increasing over the years!
3) The Hotels segment saw a really bad year in FY 21 - owing to COVID and immobility induced due to global lockdowns.
This is how segment level analysis helps us gauge which segment is driving the revenues and which segment is growing fastest/ slowest. Gathering more colour around business logic behind the numbers will give you a really good understanding of the industry/ segment the businesses are operating in (Like we did in case of ITC). For now, we will only be focusing on these two analysis notes. The rest of the segmental analysis cuts around assets/ ROIC and ROCE will be taken afterwards once we have studied the assets section of the Annual report.
Please read our blog 114 analysing sources of revenue part 8 where we talk about how to analyse revenue generation from different geographies.