accounting thematic -ambit

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November 2013

Strategy

Gaurav Mehta, CFA

[email protected]: +91 22 3043 3255

Accounting Thematic Accounting quality drives alpha

Saurabh Mukherjea, CFA

[email protected]: +91 99877 85848

Karan [email protected]: +91 22 3043 3251



Strategy

22 November 2013 Ambit Capital Pvt. Ltd.

ONTENTS

Strategy: Accounting quality drives alpha………………………………………….. 3

Methodology……………………………………………………………………………. 4

Accounting quality and investment returns - Absolute scores…………………… 6

Accounting quality and investment returns - Change in scores……………….. 10

Myths around accounting quality..................................................................13

Sample bespoke - World Cargo……………………………………………..…… 16



mbit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capitalay have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Strategy

THEMATIC November 22, 2013

Sector-neutral accounting bucketsshow strong link between accounting

quality and investment returns Accountingbucket

Accountingscore

Share priceperformance

Bucket A 227 8.8%

Bucket B 198 7.7%

Bucket C 176 4.7%

Bucket D 146 -2.5%

Source: Ambit Capital research, Bloomberg

Accounting quality versus share price

performance for the Utility sector

Source: Ace Equity, Capitaline, Bloomberg,mbit Capital research; Note: Accounting score

is based on annual financials over FY08-13; stock price performance is from April 2007 toNovember 2013.

Analyst Details

Gaurav Mehta, CFA+91 22 3043 [email protected]

Karan Khanna+91 22 3043 3251

[email protected]

Saurabh Mukherjea, CFA+91 22 3043 [email protected]

R² = 52%

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Accounting score

Accounting quality drives alphaForensic accounting has been a key component of our research overthe last few years. Our forensic accounting model allows investors toscreen the BSE500 through proprietary tools which provide a quickassessment of the health of their portfolios. Such a health check isessential given the strong influence of accounting quality onshareholder returns: the top decile of BSE500 stocks on accountingquality outperforms the bottom decile by 26% per annum.

Quantifying accounting quality

Our model looks at the following key categories of accounting irregularities:balance sheet misstatement, profit & loss misstatement, cash pilferage andaudit quality. We use 11 ratios across these categories to quantify theaccounting quality for the BSE500 stocks (excluding banks and financialservices firms). The caveat, however, is that whilst these aggressive accountingpolicies raise red flags, they may not necessarily imply accounting fraud.

Accounting quality drives investment returns

Our analysis suggests that accounting quality is a significant driver of stockreturns in India. Deciles constructed based on accounting scores show a tightrelationship with stock price performance, with D1 (i.e. the top 10% of BSE500stocks on accounting quality) outperforming D10 by a whopping 26% CAGRsince April 2007. Importantly, the conclusion holds true even after controllingfor sector effects (i.e. sector effects or business model effects are NOT driving

this outperformance – see the table in the right margin). Furthermore, evenwithin a sector, we find that accounting quality has a major bearing on shareprices – see the chart on the right.

Accounting quality drives investment performance

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based onannual financials over FY08-13; stock price performance is from April 2007 to November 2013.

How can we help?

Our forensic accounting model allows us to conduct a first-level health checkof your portfolio and helps identify potential red flags in your portfolio. This is

a critical input to both our Good & Clean portfolios as well as to our bottom-upresearch coverage. On a bespoke basis for clients, we also supplement thesescreen-driven red flags with bottom-up investigative research on individualcompanies. Please contact your Ambit sales representative in case yourportfolio has not been screened yet by our forensic accounting model.

D1D2

D3

D4

D5

D6

D7

D8

D9

D10

R² = 84%

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A v e r a

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Average decile accounting score



Strategy

November 22, 2013 Ambit Capital Pvt. Ltd.

Methodology We use 11 ratios to score the BSE500 universe of firms (excluding, banks and financialservices firms) based on their accounting qualities. These ratios can broadly becategorised into four buckets.

Exhibit 1: Key categories of accounting checks

Category Ratios

P&L misstatement checks(1) CFO/EBITDA, (2) change in depreciation rate, and (3)non-operating expenses as a proportion of totalrevenues.

Balance sheet misstatement checks

(1) Cash yield, (2) change in reserves (excluding sharepremium) to net income excluding dividends, (3)provisions for doubtful debts as a proportion of debtorsmore than six months, and (4) contingent liability as aproportion of net worth.

Cash pilferage checks (1) CWIP to gross block, and (2) cumulative CFO plus CFIto median revenues

Audit quality checks(1) Audit fees as a proportion of standalone revenues,and (2) audit fees as a proportion of total auditor’sremuneration

Source: Ambit Capital research

Here is a brief description of the accounting ratios:

I - P&L misstatement checks

1 CFO/EBITDA: This ratio checks a company’s ability to convert EBITDA (which canbe relatively easily manipulated) into operating cash flow (which is more difficult

to manipulate). A low ratio raises concerns about the company’s revenuerecognition policy (because this may imply aggressive revenue recognitionthrough methods such as channel stuffing). We use a six-year median for this

measure.

2 Change in depreciation rate: We calculate change in depreciation rates foreach of the past six years (FY08-13). We then calculate the median of absolutechanges and then sort the companies on this ratio such that the company with thesmallest change in its depreciation rate receives the best score. The rationale is topenalise companies that have high volatility in their depreciation rate on a YoYbasis.

3 Non-operating expenses as a proportion of total revenues: This ratio checks

a company’s expenditure policy. A high ratio raises concerns on the authenticity ofsuch expenses. We use a six-year median for this measure.

II - Balance sheet misstatement checks

4 Cash yield: This ratio is calculated as the yield earned on cash, investments anddeposits. A low ratio could be a cause for concern, as it could mean that either thebalance sheet has been misstated or that the cash is not being used in the bestinterests of the firm. We use a six-year median for this measure.

5 Change in reserves (excluding share premium) to net income excludingdividends: This ratio is calculated by dividing the change in reserves (excluding

share premium) on a YoY basis and dividing it by that year’s PAT excludingdividends. We then take a six-year median of this ratio. A ratio less than oneindicates direct write-offs to equity without routing these through the Profit & Lossaccount and may indicate aggressive accounting policies.

We focus on four categories ofaccounting checks: P&Lmisstatement, Balance sheetmisstatement, cash pilferage andaudit quality.

total of eleven ratiosencompassing the four categoriesof checks are used to scoreBSE500 firms on their accountingquality.



Strategy


6 Provision for doubtful debts as a proportion of debtors more than sixmonths: This ratio checks a company’s provisioning policy. A low ratio raises thespectre of earnings being boosted through aggressive provisioning practices. We

use a six-year median for this measure.

7 Contingent liabilities as a proportion of net worth: This is a check on acompany’s off-balance-sheet liabilities. If this ratio is high it raises concerns on the

strength of the company’s balance sheet in the event that the contingent liabilitiesmaterialise. Given that contingent liabilities also include genuine items such asletters of credit, guarantees, bill discounting and capital commitments, weeliminate them whilst computing the figure for contingent liabilities. We use a six-

year median for this measure.

III - Cash pilferage checks

8 CWIP to gross block: We calculate the proportion of capital work in progress togross block for each of the last six years and take a median. A high ratio ispenalised; the idea is to punish firms that show consistently high CWIP relative togross block, as this may indicate either unsubstantiated capital expenditure or

delay in recognition of depreciation expense. We use a six-year median for thismeasure.

9 Cumulative CFO plus CFI to median revenues: We calculate the cumulativeCFO (cash flow from operations) plus cumulative CFI (cash flow from investingactivities) over the last six years and divide this by the last six-year medianrevenues for the company. Higher the ratio, the better. The idea is to penalisefirms which over such large periods have been unable to either generate positivecash flows from operations or alternatively where cash flow from investments have

consistently eaten away cash generated from operations.

IV - Audit quality checks10 Audit fees as a proportion of standalone revenues: We calculate standalone

audit fees as a proportion of standalone revenues for all the six years (FY08-13). A lower ratio receives a high score. The rationale is to penalise companies whichare paying their auditors too much as compared to their revenues. We use a six-

year median for this measure.

11 Audit fees as a proportion of total auditor’s remuneration: A low proportionof audit fees to total remuneration paid to that auditor indicates that the share ofaudit in the total business that the auditor derives from the firm is low and may bea cause for caution. Again, we use a six-year median for this measure.

Cumulating scores: We cumulate scores across these 11 parameters to arrive at the

final accounting score for each firm. Based on these parameters, we rank 374 firmson accounting quality in this year’s forensic exercise. We have excluded 84 banks andfinancial services firms. Another, 20 firms are excluded because their FY13 annualreports have not been published (see table on the right). A further 22 firms areexcluded due to sketchy data availability/corporate restructuring/year-end

change/limited listed history.

Data sources: We have used Ace Equity and Capitaline as data sources for theunderlying financial data whilst stock price data has been sourced from Bloomberg.We had to use Ace Equity for some data items and Capitaline for some others in orderto minimize data errors to the best of our understanding. Unfortunately neither is

entirely reliable by itself.

Please note, however, that several adjustments need to be made to each of thendividual variables which we have not detailed here. For further details on theseadjustments, kindly email the authors of this note

List of firms whose FY13 data isnot available (cut-off date is5th Nov)

Company Financial year end

ABG Shipyard Mar

Alok Inds. Mar

Amtek Auto Jun

Amtek India Jun

Bajaj Hindusthan Sep

Ballarpur Inds. Jun

BF Utilities Sep

Elder Pharma Mar

Escorts Sep

HMT Mar

KGN Enterprises Mar

Monnet Ispat Mar

Orchid Chemicals Mar

Parsvnath Devl. Mar

Pipavav Defence Mar

P & G Hygiene Jun

Rolta India Jun

Symphony Jun

Turbotech Engg. Mar

Videocon Inds. Dec

Source: Ace Equity, Ambit Capitalresearch

Note: For the purpose of this exercise,we have included HCL Technologies

(June ending), MRF and Siemens(September ending) based on their FY07-FY12 financials.



Strategy


Accounting quality and investment returns

Absolute scores

n this section, we seek to answer the following question: ‘Does accounting quality, asquantified by our model, impact stock market performance?’ For this we assess the link

between the blended forensic accounting scores for the BSE500 universe of firms,derived based on the methodology explained above using the last six years’ data, andthe stock price performance for these stocks from April 2007 to November 2013.

1. Universe level: We find that for the BSE500 universe as a whole, stock-specificaccounting scores and stock price returns do not have a significant relationship(see the exhibit below). Such a lack of correlation is not surprising given themultitude of other factors (such as the underlying fundamental performance) which influences stock price returns.

Exhibit 2: Scatter plot of accounting scores vs stock price performance for all BSE500stocks does not bring out any significant relationship

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annualinancials over FY08-13; stock price performance is from April 2007 to November 2013.

2. Decile level: To control for noise around individual stocks, we arrange thesestocks into deciles based on their accounting scores. We then find a strongrelationship between the average accounting scores of these deciles and theaverage stock price performance of their constituent stocks, suggesting thataccounting quality is a significant driver of stock returns.

Exhibit 3: Decile-level analysis points to a strong link between accounting scores andstock price performance

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accouting score is based on annualinancials over FY08-13; stock price performance is from April 2007 to November 2013.

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Accounting score

D1D2

D3

D4

D5D6

D7

D8

D9

D10

R² = 84%

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Average decile accounting score

Stock level noise leads to weakrelationship between accounting

scores and stock returns at theuniverse level (374 firms)…

…however, deciles constructedon accounting scoresdemonstrate the power of

accounting quality in shaping stock returns



Strategy


In terms of individual decile performances, the first decile (D1) has delivered stockprice returns of 13.4% CAGR since April 2007 whilst the last decile (D10) hasdelivered returns of -12.6% CAGR over this period, thus implying a close to 26%CAGR outperformance for D1 vs D10. The performance differential across decilesbecomes more evident from exhibit below.

Exhibit 4: Decile-level analysis suggests accounting quality is important

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annualinancials over FY08-13; stock price performance from April 2007 to November 2013.

3. Sector-agnostic buckets: One may argue that in the decile construction above,sector effects have not been nullified and some sectors may do better than otherson our accounting model by virtue of the nature of their businesses. The decileperformances thus might reflect serendipitous sector effects. To control for thesector effects, we now construct four sector-agnostic buckets such that ‘bucket A’comprises the first quartile of each sector on accounting scores, ’bucket B’comprises the second quartile of each sector, ‘bucket C’ comprises the thirdquartile of each sector and ‘bucket D’ comprises the last quartile of each sector.Hence, every bucket has an equal number of stocks from each sector, implyingthat the buckets are sector agnostic.

Each bucket in this case will have similar sectoral compositions and hence aperformance assessment of these buckets should enable one to assess the impactof accounting quality on stock price performance in a sector-agnostic manner.Exhibit 5 below displays these four buckets with their respective stock priceperformances. Clearly, the performance differential points to a strong linkbetween accounting quality and stock price performances even after controllingfor sector effects.

Exhibit 5: Strong link between accounting quality and stock performance even aftercontrolling for sector effects (the first entry is the accounting score over FY08-13, the

second entry is the avg CAGR stock returns in that bucket from Apr 2007 to Nov 2013)


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D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

A v e r a g e s h a r e p r i c e


Accounting score based deciles

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A B C D

A

v e r a g e p r i c e p e r f o r m a n c e

Sector neutral accounting buckets

Top accounting decileoutperforms the bottom decile by

26% on a CAGR basis

Sector agnostic bucketsconstructed with homogenous

sectoral make and differentiatedonly on accounting quality showaccounting quality drivesinvestment performance evenafter controlling for sector effects.

227, 8.8% 198, 7.7%

176, 4.7%

146, -2.5%



Strategy


4. Sector level: Next, arranging BSE500 firms into sectors and assessing the linkbetween the average accounting scores of these sectors and the average stockprice performance of their constituent stocks suggests that accounting qualitymakes a difference at the sector level as well (i.e. sectors with higher accountingquality, such as Auto, Cement, and Consumer, perform better than sectors withpoor accounting quality such as Realty, Engineering & Construction, andInfrastructure). However, this relationship is not as strong as the decile analysis in

point 2 above.

Exhibit 6: Link between accounting quality and stock price performance at the sector level is moderate

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY08-13; stock price performance isrom April 2007 to November 2013.

With an average score of 218, Auto is amongst the best sectors in our accountingmodel. The sector has generated average stock price returns of 20% CAGR overthe last six-year period since April 2007. On the other hand, Realty is the worstsector on accounting on our model with an average score of 150. The average

stock price performance in the sector has been -15% CAGR over the last six-yearperiod.

Also, stocks within the same sector exhibit a significant link between accountingscores and stock price returns in many cases. Three sectors which show stronglinks are Utilities, Engineering & Construction and IT.

Exhibit 7: Within the sector, the link between accounting and price performance—Utilities

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annualinancials over FY08-13; stock price performance from April 2007 to November 2013.

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140 150 160 170 180 190 200 210 220 230 A v e r a g e s h a r e p r i c e


Average accounting score

Realty

E&C Infra

Conglomerate Miscellaneous

Textiles

Retail

Pharma

Media

IT

CapGoods

Utilities

Shipping

Agro

Industrials

MetalsOil&Gas

Chemicals

Fertilizers

FMCG

Consumer Durables

Auto

Auto Anc

MiningCement

Logistics

Telecom

R² = 52%

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Accounting score

Link between accounting scoresand price performance is

moderate at the sector level…

… however, within a sector stockreturns show significantdependence on accounting

scores



Strategy


Exhibit 8: Within the sector, the link between accounting and price performance—E&C


Exhibit 9: Within the sector, link between accounting and price performance—IT


5. Size buckets: Finally to address the size dimension, we split our universe ofstocks into four size buckets, as shown below. Bucket 1 comprises the largest 50stocks on market cap, Bucket 2 of the next 100, Bucket 3 of the next 100 andBucket 4 of the lowest 124 stocks on market cap (thus, taking the total to 374firms).

Exhibit 10: Larger capitalisation firms have better accounting scores on average

BucketNumber of firmsin the bucket

Market cap range(INR bn)

Market cap range(USD bn)

Avg accountingscore

Avg share priceperformance

Bucket 1 top 50 ` 256-4,000bn US$4.2bn-65bn 210.9 11.3%

Bucket 2 next 100 ` 40bn-244bn US$0.6bn-4.0bn 191.5 10.9%

Bucket 3 next 100 ` 15.7bn-39.5bn US$0.3bn-0.6bn 184.5 7.8%

Bucket 4 remaining 124 ` 1.1bn-15.7bn US$0.02bn-0.3bn 174.7 -5.6%

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY08-13; stock price performance isrom April 2007 to November 2013.

As one would expect, we find that the average accounting score as well as thestock price performance varies directly with market cap, i.e. the largest market cap

bucket has the best accounting score as well as the best stock price performanceand so on.

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Accounting score

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Accounting score

Accounting quality is better forlarger caps on average



Strategy


Accounting quality and investment returns

Change in scores

The decile level and sector-agnostic buckets from the previous section suggest thataccounting quality is a significant driver of stock prices and that this holds true evenafter controlling for sector effects. In this section, we seek to answer the question:‘Does a change in accounting score impact stock market performance?’

To calculate the change in accounting score, we break the six-year period (from FY08to FY13) that we have used so far to calculate absolute accounting scores into twosub-periods—FY08-10 and FY11-13. We then use the 11 parameters to quantifyaccounting scores for each of the two sub-periods separately using the samemethodology as earlier (but for a three-year period now vs a six-year period earlier).Change in accounting score is calculated as the change in the FY11-13 sub-period’sscore over the FY08-10 sub-period’s score. Finally, we assess the link between thischange in accounting score for the BSE500 universe of firms and the stock priceperformance for these stocks from April 2010 to November 2013.

1. Universe level: We find that for the BSE500 universe as a whole, the change in

accounting scores and individual stock prices do not have a meaningfulrelationship (see the exhibit below). Such a lack of correlation is not surprisinggiven the multitude of other factors (such as the underlying fundamentalperformance) which influences stock price returns.

Exhibit 11: Scatter plot of change in accounting scores vs stock price performance forall BSE500 stocks does not bring out any significant relationship

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for theFY10-13 subperiod over FY08-10; stock price performance is from April 2010 to November 2013.

2. Decile level: Similar to the methodology used in the preceding section to controlfor noise around individual stocks, we arrange these stocks into deciles based ontheir accounting scores. Arranging these stocks into deciles based on the changein accounting scores points to a moderately strong relationship between thechange in accounting scores of these deciles and the average stock priceperformance of their constituent stocks.

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160%

(150) (100) (50) - 50 100 150

S h a r e p r i c e p e r f o

r m a n c e

Change in score (FY11-13 over FY08-10)

With accounting quality showing strong link with stock price performance, change inaccounting quality is anotherdimension meriting attention

Again stock level noise prevents

any strong link between changein accounting scores and stock

performance



Strategy


Exhibit 12: Decile level analysis points to some link between the change in accountingscores and stock price performance but only a moderate one

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for theFY10-13 subperiod over FY08-10; stock price performance is from April 2010 to November 2013.

3.

Market and sector level: Surely, when one is looking at changes in accountingscores over time, one is keen to know: (1) At the market level, are accountingratios improving or worsening over time? (2) At the sector level, are accountingratios improving or worsening over time?

In the exhibit below, we highlight the proportion of ratios that are improving overtime (i.e. in the FY11-13 period vs the FY08-10 period). It is heartening to see thaton aggregate 70% of ratios have improved for India Inc.

Exhibit 13: Improvement in accounting ratios at the overall market and sector level

SectorProportion of ratios improving

(FY11-13 over FY08-10)Stock price CAGRsince April 2010

Universe 70%

Auto Anc 80% 18%

Media 80% 2%

Auto 70% 17%

Cement 70% 1%

nfrastructure 70% -22%

Logistics 70% 6%

Pharma 70% 12%

Retail 70% 18%

T 60% 4%

Realty 60% -12%

Agro 50% 13%

Capital Goods 50% -8%

Chemicals 50% 12%

Consumer Durable 50% 18%

Fertilizers 50% 4%

Oil & Gas 50% -9%

Shipping 50% -25%

Telecom 50% -5%

Conglomerate 40% -13%

Engineering & Construction 40% -24%

FMCG 40% 26%

ndustrials 40% -3%

Metals 40% -20%

Mining 40% -16%Utilities 40% -16%

Textiles 30% 14%

Source: Ambit Capital research, Bloomberg

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-80 -60 -40 -20 0 20 40 60 80 A v e r a g e s h

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Average change in decile score

uto Anc, Media, Auto, Infra areamongst the most improved

sectors on accounting quality…

…while Textiles, Mining, Utilities,FMCG and E&C show

deterioration



Strategy


At the sector level, the ratios of Auto Ancillaries, Media, Auto, Cement andInfrastructure have improved. Utilities, Textiles, Metals & Mining and Engineering& Construction bring up the rear of this table, as most ratios have deteriorated for

these sectors.

4. Size buckets: Finally, we split our universe of stocks into four size buckets exactlyin accordance with the method described in the preceding section. We find that

the improvement in accounting scores is the most for the lower market capbuckets.

Exhibit 14: Not much of a link between capitalisation and change in accounting scores

BucketNumber offirms in thebucket

Market cap range(INR bn)

Market cap range(USD bn)

Proportionof ratios

improving

Average stockprice

performance

Bucket 1 top 50 ` 256bn-4,000bn US$4.2bn-65bn 50% 8.1%

Bucket 2 next 100 ` 40bn-244bn US$0.6bn-4.0bn 60% 6.2%

Bucket 3 next 100 ` 15.7bn-39.5bn US$0.3bn-0.6bn 70% 6.9%

Bucket 4 remaining 124 ` 1.1bn-15.7bn US$0.02bn-0.3bn 70% -14.2%

Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for theFY10-13 subperiod overt FY08-10; stock price performance is from April 2010 to November 2013.

Overall, here are some of the key findings from an analysis of accounting qualitychange over time:

At the universe level, the accounting quality of India Inc seems to be

improving.

At the sector level, Auto Ancillaries, Media, Auto, Cement and Infrastructurehave improved the most.

At the sector level, Utilities, Textiles, Metals & Mining, FMCG and Engineering& Construction have deteriorated the most.

Improvement in accounting ratios is more prominent for lower market capstocks.

Improvement in accounting ismost for lower capitalization

stocks helped by a lower base to start with



Strategy


Myths around accounting qualityWe now turn to some common myths around accounting quality that we haveencountered over the years and show why they are incorrect.

Myth 1: Accounting quality is secondary to published financial results. Wehave long believed that accounting score is a better indication of a firm’s underlying

health than the published results, especially in a market like India where the termindependent auditor’ is often an oxymoron given that the auditor is, in effect,compensated by the promoter (rather than by the minority shareholder).

n this regard Financial Technologies stands as an interesting example. Over the pastseveral years, this company has received low scores in our forensic accounting model.However, based on the reported financials, the firm has shown 24% EPS CAGR and33% BVPS CAGR since FY07. Using our forensic accounting model, we find thatamongst the key drivers of Financial Technologies’ low accounting scores are a highproportion of non-operating expenses to total revenues along with a consistentlynegative and high CFI with respect to CFO.

Myth 2: The market already knows and discounts firms which have pooraccounting quality. After all Satyam did trade at a P/E discount to Infosys and Wiprobefore the promoter owned up to aggressive accounting. However, the stock stillcrashed by over 90% within two days of the fraud being made public.

We also find no correlation between P/E and accounting scores at the market levelnor do we find anything significant at an intra-sector level. The market simply doesnot know which companies books are cooked.

Exhibit 15: No correlation between accounting qualityand P/E at the market level

Source: Company, Ambit Capital research

Exhibit 16: No correlation between accounting qualityand P/E for E&C stocks


Myth 3: In sectors such as E&C, Utilities and Capital Goods, weak accountingquality is a certainty. Several firms in these sectors have accounting scores that arefar superior to the market average, including Elgi Equipment, Cummins India,Thermax, Engineers India, NTPC, Gujarat Gas and Torrent Power.

Myth 4: Nifty firms have good accounting quality . Whilst size bucket 1 (Exhibit 10on page 9) has the best accounting scores, this overall average hides a great deal ofvariation. For example, the accounting scores of 33% of Nifty firms are well below themarket average. For the weakest five of these firms, the accounting scores are actuallyso low that these firms are in the lowest three deciles of accounting quality for theBSE500.

R² = 1%

0

20

40

60

80

100

120

50 150 250

t r a i l i n g P / E

Accounting score

R² = 2%

0

20

40

60

50 100 150 200 250 300

t r a i l i n g P / E

Accounting score

Accounting quality is a better

indication of a firm’s health thanthe published results

Accounting quality has predictive power

Not all firms from E&C, Utilitiesand Capital Goods have weakaccounting…

… and not all firms from the Niftyhave clean accounting



Strategy


Myth 5: It takes too much time and effort to assess accounting quality on astock-by-stock basis. We can give interested clients an accounting heatmap of theirportfolio within five working days of receiving their portfolio if the constituent stocksare in our accounting model. A sample screenshot of what such a diagnostic looks likes presented below.

Exhibit 17: Indicative portfolio heatmap

Scores

Companies Ambitsector

CFOEBITDA

ContLiab-% of

NW

Change indepr rate

Audit fee-% of stan

net revs

Audit fee-%of auditor's

remuneration

Non-operexps-% oftotal revs

Cash yield

PFD-% ofdebtors

more thansix months

Cum.FCF/medi

an revs

Change inreserves/(PAT

ex dividend)

OverallScore

ABC Industrials 11 12 13 8 2 13 6 13 11 3 8.5

XYZ Utilit ies 13 8 12 9 5 12 2 7 7 3 7.3

PPP Utilities 1 5 8 10 8 8 11 11 6 3 7.4

DEF Metals 12 10 4 5 6 3 3 6 13 3 7.1

GHI Metals 10 6 7 6 1 2 12 5 12 3 6.6

RRR IT 3 2 10 12 7 10 8 10 5 3 6.7

TTT Oil & Gas 6 11 5 4 4 7 1 1 10 2 5.3

PQR Oil & Gas 7 13 3 2 3 1 4 1 2 3 4.3NGE denotes underperformance relative to the sector average

For a more detailed analysis, we also do extensive company specific bespoke researchfor clients. A sample report has been attached in the next section.



Strategy


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Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capitalmay have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

World CargoSample Bespoke Analysis – World Cargo

SAMPLE BESPOKE ANALYSIS

Analyst Details

Nitin Bhasin+91 22 3043 [email protected]

igh hopes but poor accounts Whilst the Real Estate and Metals background of the promoter couple may notprovide relevant industry experience, they do provide them with capital andrelationships. Using these advantages the promoters have built World Cargointo a force to be reckoned with in the logistics industry. Whilst primary dataand peers highlight the long-term potential of the business being created byWorld Cargo through superstar employees, a marquee advisory board and the“right regulatory reach”, the company’s accounts raise lots of questions.

Plenty of RED FLAGS

Revenue booking seems aggressive

World Cargo’s industry leading debtor days rose at a much faster pace than itspeers (Gateway, Allcargo and Concor) in FY10 whilst its revenues increasedmarginally by 4%. Despite the highest receivable days in the industry,provisions for doubtful debts remain very low at 0.3% compared to 2-20% forits peers. Concerns on revenue booking are accentuated by the appallinglylow investment income return rates for FY09 (4.8%) and FY10 (1.4%) on cashholdings whilst peers have posted 3-5% investment returns on cash.

Understated depreciation expenses boosting earnings?

Significantly low depreciation rates vis-à-vis peers on buildings and the RailLicense Fee appear to be inflating the net earnings of the company. Despitepeers amortising the Rail License Fees on a straight line method over the 20

years of concession period, World Cargo’s choice of amortising it usingmanagement estimates of revenues and operational usage over 20 yearsappears to be aggressive (given that investments and operations may not panout as expected by the management).

Auditor certification for not even half of the income and balance sheet!

World Cargo changed its auditors at the beginning of FY10 to ABC & Co. fromBig4 as Big4 expressed its unwillingness to continue (source: BSE). Whilst wedo not consider the accounts of other companies audited by ABC & Co. (ZeeGroup and Welspun) as topnotch, what worries us the most that neither Big4nor ABC has audited ~50% of revenues and Balance Sheet for the last2-3 years. Whilst international revenues dominance does explain the gap onaccount of audited revenues, we fail to understand that why the main auditor

does not audit the nearly 10% of consolidated revenues and 30% of theconsolidated assets of the Indian subsidiary World Cargo Rail Infrastructure(audited by LMN & Associates).

Snapshot

Section Notable findings

Accounting analysis RED FLAG in respect of CFO/EBITDA and debtor days

Expense manipulation RED FLAG in respect of depreciation

Cash manipulation RED FLAG in respect of unclassified loans and advances

Fictitious revenues booking RED FLAG in respect of investment income returns

Debtors provision RED FLAG

Auditors RED FLAG

Source: Ambit Capital research



Sample Bespoke Analysis – World Cargo

Ambit Capital Pvt. Ltd.

Accounting analysisExhibit 1: Revenue Recognition

Company\Metric CFO as a % of EBITDA Debtor days

FY08 FY09 FY10 FY08 FY09 FY10

Gateway Distriparks (Gateway) 85% 75% 132% 38 38 46

Allcargo Global Logistics*(Allcargo) 88% 37% 86% 47 41 47

World Cargo 18% 44% 24% 59 83 143

Container Corporation of India (Concor) 78% 86% 65% 1 2 2

Average (A) 67% 60% 77% 36 41 60

Average (ex-Concor) (B) 64% 52% 81% 48 54 79

World Cargo divergence from peer groupaverage (A)

-49% -16% -53% 23 42 83

World Cargo divergence from peer group(excl Concor) average (B)

-45% -8% -57% 11 29 64

Source: Company, Ambit Capital research, Note: (a)* Dec year end, year end for other companies is March; (b) We have used Annual report of CY07, CY08 andCY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies; (c)CFO/EBITDA for Allcargo is calculated after adjusting for the exceptionalitems of Rs-26.3mn and Rs5.6mn in CY08 and CY09, respectively and World Cargo’s EBITDA for FY08, FY09and FY10 is adjusted for the forex losses and loss on

sale of asset included under other expenses

World Cargo’s CFO/EBITDA declined significantly in FY10 as CFO declinedby 35% due to increased working capital investments while EBITDA increased21% on a YOY basis. However, after detailed analysis of the CFO and EBITDA for World Cargo for FY09 and FY10, we find the following “unexplained anomalies”,

which raise a RED FLAG:

1 In FY10, World Cargo reported “Loss on foreign exchange fluctuations (net)”of Rs31.3mn under “Administrative and Other Expenses” in its P&L whilereporting a GAIN under “Exchange Adjustments” of Rs167.3mn in thecashflow statement, and

2 In FY09, World Cargo reported “Gains on foreign exchange fluctuations

(net)” of Rs37.7mn under “Other Income “in its P&L while reporting a LOSSunder “Exchange Adjustments” of Rs161mn in the cashflow statement.

If the above amounts were to be adjusted from CFO and EBITDA (consideringthat such foreign exchange investments were on account of operations) then theCFO/EBITDA for FY09 and FY10 would be 18% and 52%, thus trending in line with its peers. Non-disclosure of the nature of these foreign exchangeadjustments needs explanation by the company.

World Cargo’s debtor days have always been ahead of its peers and have shot upsignificantly in FY10. Debtor days for Gateway and Allcargo have beenconsiderably lower and more stable compared to World Cargo. Whilst WorldCargo’s debtors increased nearly 100% on a YOY basis (Rs2.7bn in FY10 fromRs1.47bn in FY09), revenues grew by a nominal 4%. Part of the increase indebtors can be explained by a substantial increase in revenues from the railfreight business (FY10 revenues of Rs482 mn from Rs20 mn in FY09). But such ahigh jump in debtor days (when the industry has not witnessed such a trend) anda low and declining provision for doubtful debts (see exhibit 6) raise a RED FLAG.





Exhibit 2: Depreciation rate comparison

Company\Metric Depreciation rate (%) YoY change in depreciation

rate (bps)

FY08 FY09 FY10 FY09 FY10

Gateway 5.1% 5.4% 4.7% 33 (69)

Allcargo* 5.6% 7.1% 6.7% 145 (39)

World Cargo 17.1% 8.7% 4.9% (838) (376)Concor 5.0% 4.7% 4.8% (25) 6

Average 8.2% 6.5% 5.3% (171) (120)

World Cargo divergencefrom peer group average

8.9% 2.2% -0.3% (666) (257)

Source: Company, Ambit Capital research , Note: (a)* Dec year end, year end for other companies is March.(b)We have used Annual report of CY07, CY08 and CY09 Allcargo and Annual report of FY08, FY09 and FY10 forother companies

The depreciation rate for World Cargo has sharply declined over FY08-10because World Cargo has added nearly Rs2.3bn of gross block in its logisticsbusiness over last two years on the Rs301mn of gross block of its erstwhile

technology business. Moreover, a high proportion of land in the gross block(FY10: 22%, FY09: 14%, FY08: NIL) and a significant decline in the softwaregross block (FY10:0.3%, FY09: 21%, FY08:71%) has led to a sharp decline in thedepreciation rate. Freehold land accounts for 3% and 17% of the gross block of Allcargo and Gateway, respectively.

Despite a lower proportion of land in gross block, Allcargo’s high depreciationrate is on account of high depreciation rates (9-13%) on Plant & Machineries,heavy equipment and furniture (which account for 42% of gross block).

Whilst World Cargo’s FY10 depreciation rate is closer to the peer , we highlightthat World Cargo’s depreciation policy should be read taking note of the

following:

1 World Cargo depreciates “Rail License fees” after considering the matchingconcept of revenue, on a weighted of the agreement period, projectednumbers of rakes to be utilized over the said period and annual usage periodof the operational rakes since put to use. The Rail License agreement period is20 years from the date of commencement of commercial operations in 2007.This depreciation policy is materially different to Gateway’s policy ofamortising Rail License Fees on a straight line method over the life of theagreement i.e., 20 years. Effective Rail License Fee amortisation rate for WorldCargo in FY10 was 0.8% as against 5% for Gateway. Underreporting ofdepreciation forms the basis of management’s comment “Our unique modelhas resulted in World Cargo Rail being the most profitable private container railoperator in India” in FY10 annual report (see pg27).

2 Depreciation rate on buildings (2% of FY10 gross block) for FY10 is 2.6%, which is lower than the 3.3% and 4% provided by Allcargo and Gateway,respectively.

3 World Cargo provides depreciation on its “logistics operations and relatedservices’” tangible assets on a written down value (WDV) method whereasothers depreciate it on a straight line method. However, adoption of WDVpolicy is not visible in the reported low depreciation charges.

4 The depreciation rate for World Cargo would have been higher at 5.5% in FY10 had it not capitalized pre-operative depreciation of Rs12mn.

Considering the above points, the company’s reported depreciation chargeseems low to us. RED FLAG





Exhibit 3: Cash Manipulation?

Company\MetricUnclassified loans and

adv as a % of netassets

Loans and adv torelated parties as a %

of total loans andadvances

Loans and adv torelated parties as a %

of net assets

FY08 FY09 FY10 FY08 FY09 FY10 FY08 FY09 FY10

Gateway 1.2% 1.8% 1.9% 3.1% 2.0% 1.0% 0.1% 0.1% 0.1%

Allcargo* 14.5% 23.2% 19.3% 0.5% 11.8% 7.0% 0.1% 3.6% 1.6%

World Cargo 3.4% 3.7% 6.5% 6.9% 4.8% 6.6% 0.3% 0.2% 0.6%

Concor 2.7% 2.3% 2.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Average 5.5% 7.8% 7.4% 2.6% 4.7% 3.7% 0.1% 1.0% 0.6%

World Cargo divergencefrom peer group

-2.0% -4.0% -1.0% 4.3% 0.2% 3.0% 0.2% -0.7% 0.0%

Source: Company, Ambit Capital research Note: (a)* Dec year end, year end for other companies is March.(b)We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10for other companies (c) Employees, directors, promoters, promoter group companies and associates form part ofrelated parties (d) Loans and advances to related parties include receivables as well

Whilst World Cargo’s “unclassified loans and advances” as % of net assets arelower than its peer , the concerning fact is that the ratio nearly doubled in FY10

when the peer numbers either declined or remained stable. World Cargo’s ratiodoubled as the unclassified loans rose by 94% to Rs434mn, whilst net assets andrevenues grew by a nominal 12% and 4%, respectively. Such a sudden increase without adequate disclosure and a proportionate increase in revenues is

concerning. RED FLAG

World Cargo’s loans and advances to related parties mainly comprise ofreceivables from “Enterprise owned or significantly influenced by KeyManagement Personnel or their relatives.” Whilst revenues from these entitieshave declined by 31% YoY in FY10 to Rs371mn, the receivables from theseentities increased by 178% to Rs39mn (31 receivable days on these revenues inFY10 as against 9 days in FY09). Revenues from these entities account for 7% ofconsolidated revenues but receivables from these entities account for just 1% of

receivables.

Exhibit 4: Fictitious Revenue Booking?

Company\MetricInvestment income as a % of cash and marketable

investments

FY08 FY09 FY10

Gateway 7.8% 8.1% 4.0%

Allcargo * 6.1% 6.1% 14.9%

World Cargo 4.2% 4.8% 1.4%

Concor 9.8% 10.3% 7.8%

Average 7.0% 7.3% 7.0%

World Cargo divergence from peer group -2.8% -2.5% -5.6%

Source: Company, Ambit Capital research Notes: (a)* Dec year end, year end for other companies is March.(b)We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10for other companies. (c) Investment income comprises of interest income, dividend income, profit/loss on sale of(current and not strategic) investments (d) Investments comprise of marketable/current investments and excludeinvestments in associates.

Whilst high holdings of cash can be the reason for low level of investment incomereturns for World Cargo in FY09 (cash accounted for 100% of “cash and marketableinvestments”), the significant drop in investment return rate in FY10 despite cashlevels rising raises a RED FLAG. Cash accounted for 99% of “cash and marketableinvestments” and grew by 10% in FY10 to Rs723mn. However, cash also accounts for84% and 100% of “cash and marketable investments” for Gateway and Concor,respectively, and yet those firms post higher investments return rates.

Whilst Concor’s cash holding is relatively very high (Rs16 bn), World Cargo’s cashholding (Rs688mn) is very close to Allcargo’s (Rs964mn) and Gateway’s (Rs775mn).





Hence prima facie there should not be much of a difference between the cash returnsposted by the latter three.

Concor’s high investment return rates can be explained by the interest income thatthe company may be booking on its loans to employees that does not form part ofthe cash and marketable investments and high cash holdings parked in high returnfixed deposits. Allcargo’s high investment return in FY10 was on account of

“unexplained” “profit from sale of shares” of Rs204mn (81% of the investmentincome) from untraceable and undisclosed shares in the balance sheet. Adjusting forall other investment incomes, Allcargo and Gateway posted 4% and 4.4%income on cash holdings as against 1.4% reported by World Cargo. Could itbe the case that the company has under-reported investment income?

Detailed analysis of World Cargo’s investment income return is moreconcerning as it shows that despite cash and marketable securities remaining nearlystable in FY10 (see exhibit 6), investment income has shown a sharp dip. Furtheranalysis highlights that the interest income includes interest received on loans andadvances and cash deposits. As highlighted in exhibit 4 loans and advances havedoubled in FY10, which means that interest income should increase in FY10compared to FY09, but there is a sharp decline in interest income of Rs31mn in FY10.

This inconsistency supports our earlier ascribed RED FLAG on this front.

Exhibit 5: Interest and Dividend Income for World Cargo as % of Loans andAdvances, Investments and Cash

Rs mn, unless otherwise stated FY08 FY09 FY10

Interest income on loans, deposits etc. 25 41 10

Dividend on Investments in liquid mutual funds 35 31 0.4

Total Interest and other income 60 71 10

Loans and Advances 186 273 547

Cash and Marketable Investments 2,313 657 723

Total Loans +Investments+ Cash 2,500 930 1,270

Other Income as % of loans, investment andcash (%) 3.9% 4.1% 0.9%


Exhibit 6: Debtors Provisions

Company\Metric Provision for bad debts as % of Debtors

FY08 FY09 FY10

Gateway 20.6% 17.4% 20.0%

Allcargo* 0.4% 1.8% 1.7%

World Cargo 0.3% 0.7% 0.3%

Concor 6.4% 9.0% 12.0%

Average 6.9% 7.2% 8.5%

World Cargo divergence from peer group -6.6% -6.6% -8.2%

Source: Company, Ambit Capital research Note: (a)* Dec year end, year end for other companies is March.(b)We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10for other companies.

Despite World Cargo having the highest debtor days (see exhibit 2) amongst itspeer set, World Cargo has maintained the lowest provisioning for its doubtfuldebtors. Given such a low number and given that it is early days for World

Cargo’s logistics business, we assign a RED FLAG on this front.





Exhibit 7: Contingent Liabilities for World Cargo

ParticularsFY09 FY10 Contingent Liability

as a % of NetworthContingent Liabilityas a % of Networth(Rsmn) (Rsmn)

Disputed Income -tax demands 22 7 0.40% 0.10%

Claims against the company notacknowledged as debts

16 30 0.30% 0.40%

Guarantees issued by bank on behalf ofthe group 18 58 0.30% 0.90%

Guarantees and counter guaranteesgiven by the company

609 4,359 10.20% 65.10%

Amount outstanding towards Letters ofcredit given to bank

544 644 9.10% 9.60%

Custom duty on pending exportobligation against import of capitalgoods

60 138 1.00% 2.10%

Total Contingent Liabilities 1,268 5,236 21.20% 78.20%


Contingent liabilities as a % of networth has increased by 2.7X because theguarantees and counter guarantees given by the company have increased by6.2X in FY10. These guarantees are given to the banks in respect of secured loan

facilities granted to wholly owned subsidiaries of the company for Rs2.1bn inFY10 (Rs495mn in FY09); these numbers for guarantees and counter guaranteesremain same as in the stand-alone accounts.

Auditors

World Cargo International changed its auditors in FY10 (Aug-09) from Big4 toABC & Co., a firm engaged in business consultancy, tax regulation, advisory services,internal audit and risk consultancy.

ABC & Co also audits the accounts of Zee Group and Welspun Corp (flagshipcompany of Welspun Group) neither of whom are corporates whose accounts wouldbe rated first rate by us. We assign a RED FLAG for World Cargo’s audit quality:

1. Big4’s unwillingness to audit the accounts of World Cargo at the end of FY09;and

2. Continuing non-disclosure of the auditors auditing nearly 50% of revenuesand now 58% of the group’s assets. What is more concerning is the fact thatnearly 29% of these assets are from an Indian subsidiary “World CargoRail Infrastructure.” Accounts of World Cargo Rail Infrastructure are audited by aMumbai based firm, LMN & Co for the last two years.

Exhibit 8: Rising share of unaudited balance sheet by the main auditor

Sales Assets

In mn, unless otherwise stated FY08 FY09 FY10 FY08 FY09 FY10

Consolidated (A) 4,012 5,034 5,259 5,061 7,291 12,431

Amounts not audited by the main auditor (B) 2,018 2,499 2,530 929 3,364 7,182

B as % of A 50.3% 49.6% 48.1% 18.4% 46.1% 57.8%






Exhibit 9: Audit Fees comparison with peers

Company\Metric Audit fees as % of sales

FY08 FY09 FY10

Gateway 0.10% 0.07% 0.06%

Allcargo * 0.18% 0.11% 0.19%

World Cargo 0.16% 0.17% 0.18%

Concor 0.01% 0.01% 0.01%

Average 0.11% 0.09% 0.11%

World Cargo divergence from peer group 0.05% 0.08% 0.07%

Source: Company, Ambit Capital Research: Notes: (a)* Dec year end, year end for other companies is March.(b)We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10for other companies. (c) Audit Fees includes - Statutory fees, Out of pocket expenses and other audit expenses

Whilst the audit fees as % of sales has marginally increased over the years for WorldCargo, it is significantly higher compared to the Gateway and Concor on account ofhigher out of pocket expenses and other audit expenses. These expenses havedoubled in FY10 compared to FY09. Hence we attach a RED FLAG.

Exhibit 10: Break-up of Audit fees of World Cargo International

Auditors' RemunerationFY09

(Rs mn)FY10

(Rs mn)% of totalaudit fees

% of totalaudit fees

Statutory audit 7.9 7.0 91.3% 73.2%

Other Services 0.6 1.6 7.3% 16.4%

Out of Pocket Expense 0.1 1.0 1.4% 10.4%

Total 8.7 9.5 100.0% 100.0%






Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking & Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Banking & Financial Services (022) 30433205 [email protected]

Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]

Nitin Jain Technology (022) 30433291 [email protected]

Pankaj Agarwal, CFA Banking & Financial Services (022) 30433206 [email protected]

Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]

Parita Ashar Metals & Mining (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 [email protected]

Ravi Singh Banking & Financial Services (022) 30433181 [email protected]

Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile / Healthcare (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 [email protected]

Utsav Mehta Telecom / Media (022) 30433209 [email protected]

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

E&C = Engineering & Construction




Explanation of Investment Rating

nvestment Rating Expected return(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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20. The research report is solely a product of AMBIT Capital21. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report22. Any subsequent transactions in securities discussed in the research reports should be effected through J.P.P. Euro-Securities, Inc. (“JPP”).23. JPP does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports.24. The research analyst(s) preparing the research report is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that therefore the

analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply withU.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

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