Sunday, May 06, 2007
The RBI's monetary policy for 2007-2008 has helped bring hedge funds within reach of the Indian market. Till now, hedge funds have been hesitant to register directly with the Indian stock market regulator, preferring to invest in India through FII sub-accounts.
Though the Securities and Exchange Board of India (SEBI) has laid down the guidelines for the direct registration of hedge funds, the latter have not yet come forward to do so.
The alternative investment industry has also not thus far shown any interest in tapping the Indian investors for raising funds.
The money infused in the Indian stock market by the hedge funds has been raised overseas, in the US, Europe and elsewhere.
But the changes made in the recent Monetary Policy of April 24 might alter the mindset of hedge funds regarding the fund-raising potential in India.
The RBI, in a bid to usher in greater capital and current account convertibility of the rupee, has increased the present limit for individuals for any permitted current or capital account transaction from $50,000 to $100,000 per financial year.
The restriction of capital convertibility to $50,000 was one of the reasons why hedge funds were not interested in marketing their products in India.
The SEBI report on hedge funds states: "As long as there will be restriction on capital account convertibility, foreign hedge funds, by virtue of their investment limit being $1,00,000 or higher, do not seem to be excited to access investment from Indian investors in India."
Hedge funds typically restrict the number of investors to below 100 or confine membership to qualified purchasers who are high-net-worth individuals with investments above $5 million.
The minimum investment in a hedge fund was, therefore, high, at $1 million and above.
The drive to raise more capital and to expand the assets under management is driving hedge funds to decrease the minimum investment to $200,000, or even $100,000.
Another way hedge funds have been made accessible to retail investors is through the launch of mutual funds that invest in hedge funds. These funds of funds are listed and traded on stock exchanges and are subject to regulations.
Investors with a lower investment threshold, seeking an exposure in these instruments find them a viable option.
We have come a long way from the time when hedge funds were eyed warily.
Governments and regulators across the globe are acknowledging the need for these funds to impart liquidity and to refine the pricing system in stock markets.
Why Hedge Funds
These instruments are gaining popularity, not only among aggressive investors but also among the more conservative lot, such as pension funds, charitable institutions, university trusts, and so on, that are taking advantage of the tax benefits offered by offshore hedge funds to diversify their portfolios and enhance returns.
Hedge funds have many features that differentiate them from other investment avenues.
They seek absolute returns and not relative returns, such as those sought by mutual funds.
That is, they do not benchmark their performance with any equity index, so that the return generated is not correlated with the equity market.
That makes them ideal instruments for diversifying risk. Many hedge funds hedge their purchases by selling options to protect the capital in adverse market conditions.
The managers of these funds typically own a significant portion of the fund, apart from charging management fees and performance fees that are related to the fund's performance. This ensures that the assets under management will be put to optimal use.
Though many of the hedge funds do take a call on the market direction and take positions accordingly, it would be unfair to say they cause market volatility.
Need for regulatory framework
It is, of course, understood that investment in hedge funds should only be undertaken by `sophisticated' investors with deep pockets.
The US Companies Act restricts individuals based on their net worth and monthly income from investing in these instruments.
Plenty of groundwork needs to be done before hedge funds are marketed freely in India.
SEBI will need to formulate detailed guidelines, paying particular attention to the marketing of these products to ensure that investors are adequately appraised of the associated risks.
Valuation of assets held by these funds and mandating periodic disclosures to investors and the regulator are other areas that will need to be addressed.
A A Sarma
Executive Vice President, IDBI Capital
"Inflation concerns will hang over the market in the near term. Government policies to control inflation will affect margins and continue to drive investor sentiments. In the past year, inflation was high not because of primary articles but on account of energy and non-primary articles. The figure will remain moderate to low in the first half of 2007 due to the base effect but it is bound to escalate in the second half. It is a demand -pull inflation and increase in demand in the commodity space will fuel the rise. The challenge for the Government will be to regulate this.
Market, however, will remain bullish in the long term. In the next 5 years, Sensex will touch the 25,000 -mark. As demand will be greater than the supply, companies will make higher profits, and so the market will touch new levels. But volatility will be high. Global cues will be a major factor in determining market movement.
According to a RBI report, Rupee is overvalued. We, at IDBI Capital feel rupee will depreciate in the near future. However, in the long term, it will again appreciate.
Most infotech stocks posted positive results in the quarter ending March 2007, despite the appreciation in Rupee. The Re factor will impact the margins of IT firms in the next quarter but the leading software giants will overcome the tide. IT big boys, Infosys, Wipro and Satyam, which run business on the international platform, will be able to mitigate their risks by working in several markets. Countries like Vietnam and Kazakhstan are profitable markets for our tech companies.
A sound option for any investor is to make systematic monthly investment in nifty index funds. One ought to stay invested atleast for a period of three years. Then, one could partly harvest the funds and keep reinvesting the rest.
Investing in a basket of signature stocks like Reliance, ONGC, State Bank of India, Infosys and TCS would also give good returns. Energy and baking stocks will perform well in the medium term. When inflation figures are high, bank spreads usually go up. Many of the banking scrips are undervalued in terms of their book value. Investment in combination of PSU bank stocks is another sound option. One could keep a tab on performance of SBI, Punjab National Bank, Bank of Baroda, Canara Bank, etc.
Commodity prices move in a cyclical fashion. There has been a correction in prices of commodities like metal and copper. These stocks will bounce back in the medium term. We would also be bullish about cement, IT and infrastructure stocks. Companies like Bhel and ABB have been performing well. However, there will be a slowdown in growth rates in the housing sector. In the Mid cap segment, healthcare equipment stocks will be on a roll."
Investors with a high-risk appetite and medium-term investment horizon can consider subscribing to the book-built initial public offering of MIC Electronics.
The offer price has been fixed in the price band of Rs 129- 150 . The strengths of this offer stem from the company's first-mover advantage in the niche area of LED (Light Emitting Diode) video display business, the ability to scale-up outdoor advertising market from a relatively low base, and a reasonably good order pipeline in this segment.
On the flip side, however, in a price-sensitive market, the nascent LED display segment is likely to encounter competition from cheaper media applications , risks arising from execution and technological obsolescence and relatively high exposure to low margin telecom segment.
In this backdrop, we will be comfortable if the final offer price is fixed at the lower end of the price band. At the upper end of the price band, the price-earnings multiple works out to 14 times the 2006-07 per share earnings on an annualised and fully diluted basis.
MIC Electronics' business can be broadly categorised under three segments — media, infotech and telecom.
The core business segment for MIC Electronics will be media. This segment is focussed on the development, production and sale of video displays, text, graphic animation and display services. According to the US-based EDG Research, MIC Electronics is the only Indian company that has the capability in the field of LED video display systems. This segment is expected to cater to the requirements of sport and live events; electronic billboards/hoardings and news advertising ticker displays; indoor applications such as shopping malls, airports and other mobile applications.
Utilisation of funds
Of the offer proceeds of Rs 65-76 crore, a chunk is to be utilised towards setting up additional facility for LED video display.
For the year-ended June 30, 2006, the media segment accounted for 31.4 per cent of sales at Rs 31.9 crore, recording a near three-fold rise from the previous year. The operating profit margin of this segment also improved to 30.7 per cent, up from 22.6 per cent in the same period. According to the offer document, though the number of screens sold by MIC dipped to 25 (from 36 in the previous year), the number of modules sold shot up to 1,681 (from 602). This contributed to a four-fold rise in average module per screen and margin per screen.
On the one hand, the buoyant economic environment in India is likely to create a huge opportunity for growth of the LED display market.
At the same time, given the nascent stage of development of the outdoor advertising through LED displays, the availability of outdoor vinyl hoardings at a lower cost and competition from international companies such as Barco NV or Daktronics Inc. (subject to import tariffs), there is a possibility of fluctuation in the quarterly performance of MIC Electronics. The infotech segment, which offers telecom software solutions such as telecom network management or computer telephony, has got a leg up with the recent acquisition of 55 per cent shareholding in InfoSTEP Inc, US.
This acquisition is expected to provide MIC Electronics access to business intelligence, enterprise application and survey management services.
The telecom segment, which contributed 65 per cent of revenues in 2005-06, caters principally to CDMA/GSM-based terminals, handheld computers and digital loop carriers. The operating profit margin at 12.9 per cent, up from 8.4 per cent in the previous year, is still substantially lower than the media segment.
The book running lead manager to the offer is Edelweiss Capital. The offer opened on April 30 and closes on May 8.
Investors can consider taking exposure in the book-built initial public offering of Binani Cement. The offer is being made in the price band of Rs 75-85 per share. The proposed expansion in production capacity, prudent shift in the product mix, and the prospect of consolidation in a fragmented cement space are positives linked to this offer.
However, the downside stems from the highly competitive Northern and Western markets, with established players calling the shot in terms of pricing and brand power, indifferent past record of governance in the Binani group and the recent cap imposed by the government on cement prices for a year.
Binani Cement is a well-established player, with 2.25 million tonnes of cement capacity along with 25 MW coal/lignite based captive power plant at Sirohi, Rajasthan. It is in the process of expanding its capacity of cement to 5.3 million tonnes. Since it is servicing the high growth States of Rajasthan, Delhi, Punjab, and Haryana, in the North and Gujarat in the West, the step-up in capacity should be easily absorbed by buoyant demand in these markets.
The policy environment for the cement sector has turned somewhat murky in the past few months, with government intervention. Despite a disturbing policy environment, our invest recommendation is predicated on three key variables:
Expansion in capacity: The enhanced capacity of 3.1 million tonnes likely to be commissioned by mid-2007 will be absorbed in the high-growth Northern and Western markets. Since the cement demand-supply gap is likely to widen over the next two years, even without any significant pricing upside, volume growth and strong operating margins can keep the company's performance and, in turn, its stock on a stable footing.
As a part of its expansion in capacity, Binani Cement has increased its clinker capacity by 2.3 million tonnes and is also expected to add another 44.6 MW plant over the next few months. The entire expansion programme is expected to cost Rs 575-600 crore and, post-expansion, the debt-equity will be 1.47:1.
Shift in product mix: In tune with the overall demand, Binani Cement has consistently shifted its product mix away for OPC (Ordinary Portland Cement) used for construction purposes towards PPC (Pozzolona Portland Cement) suitable for infrastructure requirements such as building dams and barrages. PPC basically mixes fly-ash from thermal power stations with clinker in producing this cement. Between 2004-05 and 2006-07, the PPC:OPC mix has shifted from 29:71 to 51:49. Post-expansion, it is expected that this proportion will shift to 60:40 in favour of PPC.
Valuation: Based on the 2006-07 per share earnings, the price-earnings multiple of Binani Cement works out to 15-18 times at the lower and upper end of the price band. We will be comfortable if the offer price is fixed at the lower end of the band.
While this valuation is significantly higher than established peers such as ACC, Gujarat Ambuja Cement, Grasim or Shree Cement, which vary between 10 and 14 times, two key elements have to be borne in mind.
One, its operating profit margin is in line with its established peers. In 2006-07, the operating margin improved to 34.2 per cent from 27.7 per cent the previous year. With its proposed expansion, it will be able to keep its margins in this band. Two, considering the fragmented state of the cement industry, there is scope for further consolidation within the cement industry. Though the top five players command a market share of over 45 per cent in 2006, there are over 20 cement players with capacities less than two million tonnes.
With multinational players such as Lafarge, Holcim, Italcementi and Heidelberg establishing a base in the country, relatively smaller cement players may enjoy a consolidation premium.
Offer details: The listing of Binani Cement will be through an offer for sale by JP Morgan Special Situations (Mauritius) of 2.05 crore shares in a price band of Rs 75-85 per share.
The offer constitutes 10.09 per cent of the post offer equity stake of the company. The book-running lead manager is ICICI Securities. The offer opens on May 7 and closes on May 10.
Trend identification can be called the keystone of technical analysis. The price typically moves in a wave like motion forming a series of peaks and troughs. The direction in which these peaks and troughs are moving is called the trend. In an up trend, we have a series of higher peaks and higher troughs. In a downtrend, we can see successive lower peaks and troughs. When the peaks and bottoms move horizontally we call it the sideways trend.
The weekly chart of Sensex mimicking the Indian rope trick is the classic example of an up trend. Take a look at the weekly chart of Jet Airways if you want to see a downtrend. The movement of Ing Vysya Bank stock since 2004 would remind you of a heady roller coaster ride. That is a sideways trend.
Trend identification is done with the help of trend lines. Constructing a trend line is fairly simple. When the stock is in an up trend, the trend line is constructed by joining the troughs formed during the up trend. Conversely, a down trend line is formed by connecting the peaks formed during the downtrend.
Trading with trend line is also rather straightforward and it is one of the first tools that a technical analyst learns to use. A buy signal is generated when the stock price moves above the down trend line. A sell signal would be generated when the stock price moves below the up trend line.
Let us elucidate with an example. Andhra Bank has been in a downtrend ever since it peaked at Rs 98.5 in November 2006. The next significant peak was formed at Rs 92.9 on February 2, 2007. We should join these two peaks with the help of a trend line. This downward sloping trend line is positioned at Rs 86 currently. So, a buy signal will be generated only if the stock moves firmly above Rs 86.
It is often observed that the trend in a stock can vary across time frames. If we revert to Andhra Bank, the long-term trend in this stock is up, the intermediate and medium-term trends are down and the short-term trend is up. It would be safer to trade long in stocks in which the trend is bullish across all the time frame such as Reliance Capital.
An investment can be considered in the stock of Mudra Lifestyle. This recently listed textile company continues to trade well below its offer price of Rs 90. The stock, on Friday, reacted sharply to the strong earnings reported by the company; Mudra reported a 57-per-cent increase in revenues and a 90-per-cent growth in profits for FY07.
With significant capacities likely to come on stream in the first half of FY08, revenue and earnings growth is likely to be robust for the current year as well. At the current market price, the stock trades at less than 10 times its likely FY08 per-share earnings, assuming its expansion plans are commissioned as per schedule.
Textile stocks have been under pressure as a competitive export market, scaling-up challenges, and an appreciating rupee continue to weigh on performance. In this context, we favour companies such as Mudra Lifestyle that have a domestic market focus. The stock could serve as an indirect play on the domestic consumption theme.
Mudra has been a supplier of finished fabrics to garment manufacturers. It recently forayed into garments with the aim of supplying to local branded garment outfits. It appears to have garnered some orders from leading garment manufacturers, judging by the early traction in the garments business.
Mudra, with the help of offer proceeds, is tripling its garment capacities to more than 10 million pieces a year. It is simultaneously ramping up its weaving and processing capacities as well. Its garments division is likely to be operational in June. The long-term prospects for this business model appear bright.
Local branded players such as Madura Garments (Aditya Birla Nuvo) and Raymond are focusing on expanding their retail presence and are likely to look to outsourcing production to players such as Mudra. The bigger story is the demand from retailers such as Reliance and Bharti Wal-Mart as they look to stock stores with private labels.
It might take a year or two for the company to ramp up utilisations, with the new entrants yet to foray into garment retailing. Competition from exporters looking to diversify into the domestic market is also a risk. Any cooling off in prices following the sharp movement on Friday could be used as an entry point. Buy with a two-year perspective.
In an exaggerated reaction to good earnings numbers and a one-time dividend announcement, the Colgate-Palmolive India stock rose by 12 per cent in a single day (May 4).
Shareholders can retain the stock, given the relatively sound long-term prospects arising from traction in the company's growth numbers and its improving product mix.
However, after the recent sharp move the stock trades at about 32 times its trailing earnings, at a valuation premium to the rest of the FMCG space. The stock price could cool in the short term.
After an inconsistent performance in the preceding quarters, Colgate Palmolive India reported strong profit growth of 37 per cent in the March quarter of 2006-07.
The profit growth appears to be driven by an improving product mix, lower tax incidence on account of newly-commissioned facilities at Baddi, HP, and a slower growth in adspend. Sales growth also improved sequentially, from 12.8 per cent in the preceding quarter to 13.3 per cent in the latest quarter. Domestic sales of oral-care products such as toothpaste and tooth brush picked up pace recently on the back of increasing offtake from the rural and semi-urban areas. Colgate, as the dominant player in the mass-market segment (HLL does not have a presence), has been a key beneficiary of this trend.
The company's efforts at broad-basing its portfolio also appear to be bearing fruit, with the company garnering significant market shares in liquid soap and body wash segments.
The improving growth trajectory has helped Colgate close FY-07 with a healthy 15 per cent growth in sales and a 17 per cent growth in net profit.
Along with its earnings numbers for the March quarter, the company unveiled a proposal to declare a one-time "deemed dividend" of Rs 9 per share.
This move, intended to return excess capital to shareholders, has been structured as a capital-reduction proposal that will reduce the face value of each Colgate share.
This is likely to take time to implement, as it requires shareholder and court approvals.
Investors need to note that though it will eventually result in an inflow of about Rs 9 per share, this move has no direct wealth implications for them:
The capital reduction proposal will have no impact on the company's per share earnings , as the number of outstanding shares will remain unchanged. Though the proposal will reduce the face value of each share, the absolute stock price will not fall after the dividend payout.
Investors need to note that this move to return capital is different from a stock split. In a stock-split proposal, the number of outstanding shares available for trading in the stock market expands while the face value of each share shrinks.
In this case, only the face value shrinks from Rs.10 to Re 1, with Rs 9 per share being returned to shareholders. The per-share earnings and the number of outstanding shares remain the same.
The move will, therefore, not improve liquidity in the stock or reduce the absolute stock price.
However, the proposal may have an indirect impact on valuations, as it will improve Colgate's returns metrics — its Return on Equity, Return on Net Worth and Return on Capital Employed numbers.
This is because Colgate will be liquidating Rs 122 crore worth of low-return yielding investments (now part of its net worth) and carried by its treasury operations, to fund the deemed dividend.
Though investors who buy the stock now will be entitled to dividends of Rs 18.5 per share over the next year (Rs 9.5 annual dividend plus Rs 9 special dividend), the sustainable dividend per share amounts to only Rs 9.5 (this amounts to a sustained dividend yield of less than 3 per cent on current stock price).
Long-term investors can retain their exposure to the stock of Praj Industries, a leading solutions provider for ethanol plants, worldwide. The enhanced interest in bio-fuels the world over, thanks to a firm price outlook for crude oil over the medium term, and the mandatory ethanol blending in petrol in countries such as the US offer a robust demand scenario for Praj Industries.
Back home, Praj is also likely to benefit from the Government's proposal to enhance the ethanol-blended petrol programme to 10 per cent from the current 5 per cent. However, despite such a healthy growth environment, the valuation appears stiff.
At the current market price, the stock trades at about 31 times its FY-08 expected per share earnings on a fully diluted basis. Short-term investors can consider booking partial profits and re-entering the stock at lower levels. Medium/long-term investors, however, can hold on to the stock.
Scaling up globalLY
Revenue contribution from the export market is likely to scale up, given the increasing business opportunities in Europe and the UK, the US and Brazil. World ethanol production, as per industry estimates, is expected to surpass 90 billion litres by 2010. Globally, over 300-400 ethanol plants are likely to be installed over the next three-four years.
Given that Praj figures among the top five global companies involved in supplying equipment for distillery projects over the past two years, its ability to benefit from such a healthy demand scenario appears promising. It is also likely to capitalise on any opportunity that could arise from the ramp-up in corn ethanol capacities in the US.
The acquisition of the US-based CJ Schneider, an equipment provider, is also likely to expand the client base of American operations. However, it could well be two-three years before the investment in this acquisition starts to pay back.
In the European market, the EU member-states' proposal to reduce carbon emission by 8 per cent by 2012 also offers a substantial growth potential. Envisaging the upcoming demand, Praj has entered into a joint venture with the Netherlands-based Aker Kvaerner. Praj could leverage Aker's execution capabilities and the extensive European market knowledge, while using its own technology to cater to the European market.
Encouraged by the ethanol production scenario in Brazil (estimated to double production by 2010), Praj is scouting for acquisitions to set up an operational base in the country. This, when it happens, is likely to help Praj tap the huge ethanol production market in Brazil. Praj's ability to break into new markets also lends more visibility to its earnings. However, it could face stiff competition from established players in the respective markets.
Domestic ethanol scenario
Keeping in mind the current sugar glut, the Government's decision to blend ethanol with petrol is a welcome move. With sugar prices in a downturn, sugar companies could rely to a greater extent on by-products such as ethanol for revenues and profits; capex in this segment is, therefore, likely to continue. The introduction of ethanol blending is likely to prompt sugar mills to invest additionally in improving technology and infrastructure and in setting up appropriate processes. This would be a positive for Praj.
Additionally, any policy move allowing sugar companies to directly process sugarcane juice into ethanol, would improve the economics of ethanol production and generate additional orders for Praj.
However, given that the sugar industry is subject to various policy controls ranging from the Sugarcane Control Order to the Essential Commodities Act, the ethanol-blending programme is likely to remain heavily reliant on government policies. Furthermore, licensing and procedural requirements, levy of a plethora of taxes and restriction of inter-State movement of industrial alcohol also remain challenges for the smooth implementation of this programme.
The R&D wing of Praj, dedicated to ethanol technology, offers it a competitive advantage over other players. Its foray into biofuels technology could also offer a sizeable potential growth, given that most countries are major diesel consumers and nearly 60 per cent of the incremental growth in world transport fuel is diesel-based.
Additionally, the strategic setting up the Kandla SEZ, for the manufacture of large equipment is also encouraging.
For the quarter ended March 2007, Praj reported a 111 per cent increase in revenue on year-on-year basis, whereas the overall FY-07 revenues grew by about 127 per cent.
Operating profit margin stabilised on a year-on-year basis with a marginal 40 basis points jump to 13.7 per cent. However, the operating margins witnessed a decline of 10 per cent on a sequential basis, on account of a differing product mix.
This can be attributed to the realisation of a higher proportion of equipment technology revenues (during the third quarter), which yield better profitability for the company. The overall FY-07 earnings expanded more than doubled, aided by a higher volume growth and lower tax incidence.
Since the European and American markets are likely to drive Praj's growth, any slowdown in the capacity expansion plans in these countries could affect the earnings for Praj.
This apart, any steep decline in crude oil prices could temper the interest in ethanol, which is mainly owed to its favourable cost economics. This could, in turn, discourage companies from setting up newer capacities for ethanol.
Global technology advances in biofuels could undermine Praj's competitive edge, if it does not keep up; this remains a key risk.
On the domestic front, any adverse changes in the government policy relating to export, import or pricing of sugar could have a negative impact on the company's earnings.