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Shedding Excess Weight

Impairment charges can affect companies' stock prices in certain conditions. Here's the low-down on what it entails.
Rahul Oberoi/Money Today | Print Edition: August 2013

Tata Steel shareholders got a shock when the company reported its biggest-ever quarterly loss in March. The steel-maker reported a net loss of Rs 6,678 crore for the January-March period compared with a net profit of Rs 203 crore in the year-ago quarter.

The reason for the fall was the company's decision to reduce the value of foreign assets in its books by Rs 8,356 crore. The write-off, called impairment charge, is a non-cash event that does not directly impact finances of the company concerned. That is why the decision did not hit Tata Steel's shares; the stock touched Rs 314 on May 29 as against Rs 299.50 on May 23, the day the results were announced.

"Unless there is a material change in earnings, cash flow and leverage, the impact of impairment on a company's valuation may be negligible. There is no reliable way to forecast the stock movement after a company decides to take an impairment hit," says Vaibhav Chavan, dealer, wealth management, Equentis Capital.

In spite of this, impairment does affect some ratios used to value companies and, thus, how the market perceives the company in question.

BY THE BOOK
Companies opt for impairment when the value of assets/goodwill on their books is no longer fully recoverable. "This is done when the asset's fair value or ability to generate cash falls," says Jamil Khatri, global head of accounting advisory services, KPMG. "Impairment charge implies writing off of worthless goodwill," says Chavan of Equentis.

In Tata Steel's case, the impairment was for the goodwill that was created when it bought UK's Corus in 2007.

GOODWILL AFFECT

Quote

An impairment charge is generally an indicator of adverse business conditions.

JAMIL KHATRI

Global Head of Accounting Advisory Services, KPMG

Goodwill is a long-term asset categorised as intangible, just like brands, patents, trademarks and customer loyalty. It arises when a company acquires another. Its value-the money paid to buy the business minus the fair market value of its tangible assets-is lowered in the acquirer's books if the value of the acquired company falls.

For instance, Tata Steel said it would write off goodwill and tangible assets worth $1.6 billion during financial year 2012-13 for the loss of value of Tata Steel Europe, formerly Corus, plus other assets in Thailand and South Africa.

ACCOUNTING TREATMENT
Impairment charge is entered as an expense in the profit & loss account. The carrying amount of the asset is reduced by the impairment amount. This reduces the company's net worth or book value. The net profit, too, is adversely affected in the year the charge is made. However, such a charge may be extraordinary or onetime in nature and may or may not be relevant for the company's future financials.

FOR INVESTORS
The charge helps investors get an accurate idea of the value of the company's assets. "Assuming it's a one-off case, it cleans up books and improves ratios such as return on assets (RoA), return on equity (RoE) and return on capital employed (RoCE). Since stockholders' equity falls, the debt-to-equity ratio rises. But cash flowbased ratios remain unaffected," says Chander Sawhney, vice president, Corporate Professionals, a firm that offers legal & financial services to companies.

RoA shows how efficiently the management is using assets. It is calculated by dividing annual earnings by assets. RoE measures profitability by revealing how much profit a company generates with the money invested by shareholders, while RoCE is used to measure the value of business gains from its assets and liabilities.

$1.8 bn
was the loss reported by Novelis in the 3rd quarter of 2008-09 due to a $1.5 bn impairment charge.

"Marking intangible assets like goodwill to the market provides investors more credible information," says Sanil Kumar, head of sales, Geojit BNP Paribas Financial Services.

The charge affects profits and, by extension, earnings per share. However, if the value of the asset rises in the future, the charge may be reversed in some cases. "The value of tangible assets can be written back if the situation improves in the future but not of goodwill," says Sawhney.

INDICATORS
Experts say things that can trigger impairment are a significant fall in the asset's market value and adverse changes in the technological, market, economic or legal environment in which the company operates; changes in the market rates of return or market capitalisation; obsolescence or damage to the asset; significant change in the way the asset is used; and worse-than-expected performance of the asset.

An impairment charge usually reflects a fall in value or worse-than-expected performance of the asset.

"An impairment charge is an indicator of adverse business conditions. The impact on the stock will depend upon whether the market has already factored in the downturn based on disclosures by the management. If not, it may result in an adverse impact on the stock" says Khatri.

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