Simply Put: Earnings seasonality

Two friends met over coffee and get involved in the discussion regarding seasonality in earnings season.

Vindhya: Hi Pradeep. Did you check, the quarterly results of TATA Power are out. Its revenue and PAT have grown 22 per cent and 40 per cent respectively compared to last quarter. I am glad that I have invested in the right company as its showing good growth.

Pradeep: Okay. But are you sure about comparing this quarter earnings with last quarter, and not on year-on-year basis? Have you checked if this company has any seasonality involved?

Vindhya: Why can’t we compare on a quarter on quarter basis? And what’s seasonality?

Pradeep: Seasonality refers to predictable fluctuations that occur in a financial year in a company’s business. These could be based on calendar seasons such as summer and monsoon or even commercial seasons. Due to the presence of seasonality, certain companies might earn a sizable chunk of their revenues from few specific quarter(s).

Vindhya: Do companies show seasonal earnings?

Pradeep: Let’s consider a fertiliser manufacturing company, Coromandel International. The company earns about 35 per cent of its yearly revenues from September quarter alone due to this being a monsoon quarter. During this quarter, there is higher use of fertilisers on account of sowing of crops. Similarly, Varun Beverages earns about 40 per cent of its revenue from summer quarter i.e., June ending quarter as demand for soft drinks is highest during this quarter. For such companies, comparison over the previous quarter might give you misleading results as it would indicate abnormal growth for such quarters and year-on-year comparison should be done for such companies.

Vindhya: Okay. So, you mean for every company a year-on-year comparison should be sufficient. Right?

Pradeep: No! That’s not what I meant. Every company might not be affected by seasonal fluctuations. For instance, you might not find such trend in the earnings of FMCG company HUL. That company is engaged in a diversified set of businesses such as home care, personal care, and foods. For such companies, you can make sequential quarter comparison.

Vindhya: Understood about the revenue part, but do costs also have such seasonality?

Pradeep: Yes, costs do have seasonality. Generally during the March ending quarter, employee costs will be higher due to bonuses and salary hikes. Also, the seasonality of raw materials will be reflected on the company’s P&L statement as well. Generally, the price of base metals tends to increase post monsoons when construction activity picks up, which will impact construction companies during that period.

Also, you should note that the companies which have higher revenue in a quarter due to seasonality, tend to have a spike in their EBITDA margins owing to operating leverage.

Vindhya: Okay, so ultimately there can be year on year quarterly results comparison for the seasonal businesses while sequential quarter comparison should be made for non-seasonal business.

Pradeep: Yes, I’m glad as now you’ve got clarity.

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