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Sunday, August 12, 2007
IPO Grey Market Premiums
Puravankara Projects 400 to 450 Discount
Take Solutions 675 to 730 630
KPR Mills 225 to 265 Discount
Refex 65 6 to 8
I V R Prime 550 Discount
OMNI Tech Info 105 75 to 80
Central Bank 102 40 to 42
Zylog Systems Ltd. 350 300 to 320
SEL Manufacture Ltd. 80 to 90 1 to 2.50
Asian Granito 85 to 102 5 to 7
Motilal Oswal 725 to 825 60 to 65
Small-sized IPOs have it easy
Small is beautiful and that appears to be the mantra borrowed by companies to stay in line with the current market conditions. The recent past has been no less than a roller-coaster ride with the primary market finding the going difficult.
The secondary market, which has a bearing on the IPO market, has been reeling under the backlash of the US subprime mortgage market crisis. While this may have proved to be a deterrent for the larger-sized IPOs, it appears to be godsend for companies looking to raise very small sums via public issues.
Merchant bankers said most of the small-sized issues are fixed-price IPOs relying very little on foreign money and hence looked upon as safe bets during such times. Incidentally, industry sources believe the fate of the Bangalore-based real estate development major Puravankara Projects has made companies rethink on the respective issue sizes.
The construction company was not able to garner sufficient investor interest for its recently-concluded public offering. With the issue being revised, the final issue price has been fixed at the lower end of the price band at Rs 400.
“Though, there is volatility, the market is conducive for small-sized issues”, said Ashika Capital assistant vice president Hari Surya. “Fixed-price issues are good, the only thing being that they have to rely fully on HNIs and retail investors to get sufficiently subscribed. Being fixed-price issues, there is very minimal chance of over-valuation of IPOs,” he added.
Interestingly, the coming days will witness Allied Computers International (Asia) entering the capital market with a fixed-price issue to raise Rs 6 crore. And that is not all. According to Prime Database, Circuit Systems and Saamya Biotech are also to come out with their IPOs to raise Rs 14.85 crore and Rs 15 crore, respectively.
Other companies like Supreme Infrastructure India, Barak Valley Cements and IT People (India) are also in the fray with small issues. Dagger Forst Tools has already entered the market to garner a little over Rs 16 crore. According to market watchers, a number of domestic banks,like Punjab National Bank, various subsidiaries of SBI, Canara Bank and Bank of Baroda, are investing heavily into public issues of small companies banking with them.
If one goes by what merchant bankers say, the subscription of banks to IPOs has shot up at least 10 times over the past 6-8 months. “By investing into public offerings, banks are trying to keep up their treasury income, which is under pressure due to higher income interest rates. Most banks subscribe to IPOs on hopes to make good money on listing day. This is more evident in the case of smaller issues and averagely rated public offerings”, said an investment banker.
The past has seen many a small issue do quite well. Companies like Jagjanani Textiles, Lawreshwar Polymers, Lumax Auto Technologies and Kovilpatti Lakshmi Roller Flour Mills have all raised money in the range of Rs 13-23 crore. While all the above-mentioned issues were fully subscribed, Lawreshwar Polymers was subscribed nearly six times.
“Institutional buyers generally keep away from small (fixed-price) issues as they have to mandatorily pay up the full application money at the time of applying for shares,” said Microsec Capital executive director-investment banking Rakesh
Index Outlook
Sensex (14868.2)
Markets were fixated on the sub-prime contagion last week, rising euphorically on the slightest indication that it had abated and tanking miserably when the issue reasserted itself. The mild 2 per cent loss in the Sensex does not reflect the wild intra day swings that buffeted the investors last week.
The liquidity prop that helped the Sensex cross 15000 is turning shaky now. FIIs have been net sellers in August so far. The mood in the market has not turned negative enough to indicate a bottom. The build-up in the derivatives section continuing above Rs 80,000 crore and dip in Nifty put-call ratio indicates that players are betting on the correction ending soon.
If we consider the rally from the March trough of 12316, the index has completed the minimum retracement of 38.2 per cent. If the Sensex manages to hold above 14500, the positive outlook for the intermediate term will continue. But a fall below will mean that the index will head for the band between 13900 and 14200.
Though the correction is providing lucrative buying opportunities, any buying should be staggered and done with the long-term perspective only. We are beginning to get early indications that we could have begun the correction of the 7000 points rise recorded since last June. The minimum target as per this count is 13748. Though a move below 14500 is the first requisite for confirming this assumption, some restraint in chasing stocks is called for at this point.
The reversal on Thursday and the gap-down opening of Friday have made the short-term outlook very negative for the index. Volatility would rule supreme next week too. The Sensex could try to edge up to 14942 and then 15170. Failure to move beyond 15000 would be a sign that the index is heading for another sharp dip to 14570 and then 14379. Support below will be available at 14154. A move beyond 15540 is required to make the short-term outlook positive.
Nifty (4333.3)
Nifty reversed from our second resistance at 4525 last week to end the week slightly below the 50 DMA. Thursday’s reversal could be the beginning of the third leg of the fall that began at 4643. This wave has the targets of 4297 and then 4154. Since the index is hovering above the first target, a step lower will take it to the next target.
The initial target if Nifty is correcting the move from the 2595 low is 4028. Investors should watch out for the support band between 4000 and 4050.
Resistance for the week ahead would be at 4350 and then 4419. Reversal from the first target would be very negative whereas a move above the second resistance would take the Nifty to 4530.
Global Cues
The rally in the early part of last week in the Dow Jones Industrial Average was halted at 13700, as indicated last week. A move lower to 12800 seems imminent. But the up-trend from the June 2006 will be jeopardised only on a fall below 12800.
Nymex crude too moved lower last week. The breach of the support at $71.9 is a trifle worrisome. The subsequent supports are at $69.7 and then at $67. A move below $67 will mean that the intermediate term up trend from the January low of $49.9 is complete.
IPO Duopoly
There’s science, and a little bit of madness, involved in marketing an initial public offering. The entire process is time-bound; then, there’s the thing about having to cope with developments that could range from inclement weather, which cancels a roadshow or press conference, at best to a negative research report or media report trashing the IPO at worst.
In some cases, as happened most recently with the IPO of Puravankara Projects Ltd, issues over which the company and its managers have no control can often wreak havoc with carefully laid plans: In this case, a worldwide fall in equity markets, and a dip in the Bombay Stock Exchange’s realty index, translated into weak response for Puravankara’s IPO and the issue eventually had to be repriced and its deadline extended.
All this usually happens rapidly: The actual IPO process lasts four days on average and is preceded by a fortnight of high-decibel publicity.
The pressures are compounded when several IPOs fight for subscriber money. In June 2007 alone, some Rs19,105 crore worth of IPOs hit the Indian stock market. That can work both ways. In some cases, it could mean smaller issues are ignored; in others, it could mean even smaller issues get oversubscribed because everyone is in a buying frenzy. That’s exactly what happened to the Rs110 crore IPO of Vishal Retail Ltd, which coincided with that of DLF Ltd. The issue was subscribed 81 times.
Although Rs26,118 crore worth of IPOs have hit the stock market since April, compared with Rs24,993.37 crore in all of 2006-07, there aren’t too many advertising and marketing specialists fighting it out for a slice of the business. The business is dominated by Concept Public Relations India Pvt. Ltd and the Adfactors Group. The two bundle advertising, public relations, event management and investor relations, and have a reputation for getting the job done.
Concept, a Mumbai-based communications and marketing group headed by Vivek Suchanti, marketed 13 of the 35 issues that hit the market in the quarter ended 30 June. Rajesh Chaturvedi and Madan Bahal’s Adfactors Group was a close second, with 10 issues. Together, the two agencies handled 23 of the 35, or 65%, of all IPOs in the first quarter of 2007-08.
The two companies did well in 2006-07 too, marketing 68 of the 85 IPOs that hit the stock market that year. Concept managed 33 and Adfactors, 35. That kind of dominance hasn’t made the two companiescomplacent; they compete for almost every contract, and the rivalry between them is so keen that Suchanti even refuses to refer to Adfactors by name (he calls the company “my competitor”).
The duopoly enjoyed by Adfactors and Concept is almost complete. There are two other relatively small but similar companies—Pressman Advertising & Marketing Ltd and Sobhagya Advertising Service—but their share is decreasing steadily. Pressman is owned and managed by Vivek Suchanti’s cousin Navin Suchanti.
Mkt bias negative, but can reversal happen?
The Sensex, last week, moved in our expected range of 15,550 to 14,650 till Friday when the index broke the lower end of the band. This now opens the possibility of the index drop to our earlier mentioned major support level of 13,800 (13,780 to be precise).
While alternate bouts of buying and selling would lead to huge swings in the market, the short-term bias remains bearish as long as the index is below the 15,550-mark. Jittery global markets and a holiday- shortened trading week would add to the current nervousness.
Last week, the index, after beginning on a dismal note, did extremely well to recoup its losses and gain over 400pts in intra-week trades. From an early low of 14,706, the Sensex surged to a high of 15,542 - a swing of 972 points. However, the index eventually dropped into red and finished with a loss of 270 points at 14,868. This was the third straight weekly loss for the index.
The current week could be a bit tricky one as the markets generally tend to reverse trend after three weeks. If not, the reversal may come after the seventh or the ninth week.
While the support levels for the Sensex this week are placed at 14,500-14,380-14,265, the index will face resistance around 15,240-15,350-15,470.
The Nifty swung in a near 300-pt range i.e. from a high of 4530, the index tumbled to a low of 4239 - an intra-week range of 291 points - before settling with a loss of 68 points at 4333.
The 4520-4530 levels would continue to be the major roadblocks for the Nifty and the bias will remain negative as long as the index trades below these levels. The Nifty, too, has broken its support level mentioned at 4275-4285. The index is now likely to test its lower levels of 4030 to 3960.
This week, the index may face resistance around 4445-4480-4515, while support on the downside is likely to be around 4220-4190-4150.
Axis Bank: Pricey, yet promising
Axis Bank(formerly UTI Bank) is a good investment candidate in the private banking space. This stock now trades at around Rs 590, which is a multiple of 29 times its FY-07 earnings and five times its book value. The stock has generated average annual returns of around 45 per cent since the company’s IPO in 1998.
Future returns may not match that of the past eight-nine years. But this banking stock could be a core long-term investment on account of the solid underlying financial performance of the company and good prospects of such performance being sustained, the niche positioning it is trying to achieve in the overall market and a strategically-driven management, all of which appear to have laid the foundation for long-term growth.
At these levels, the stock does appear a little pricey. But if one considers the company’s track record and the relative performance of the stock vis-À-vis its private sector peers, it would seem that the valuations are catching up only now.
The bank appears well-placed in many respects — the present levels of capital and recognition in both the domestic and overseas markets which will help in raising funds as and when necessary. The bank also has good distribution reach, created through a network of some 550 branches, with continued emphasis on the physical branch network as well as alternative delivery channels such as the Internet/off-site ATMs to drive business growth.
Resilient fundamentals
Axis Bank stands apart from its private sector competitors — ICICI Bank and HDFC Bank — in one crucial respect. While the other two banks have envisaged retail banking as a key area of strategic emphasis — with the share of the retail business (both on the funding and asset sides) growing strongly year after year— the share of retail business, particularly retail assets, has actually come down quite sharply in the case of Axis Bank.
The numbers here are quite interesting. For ICICI Bank, retail loans now (as of June 2007) account for as much as 70 per cent of the bank’s total loan book of Rs 2,00,000 crore. For HDFC Bank, retail assets are around 57 per cent (Rs 28,000 crore) of the total loans as of March 2007.
In the case of Axis Bank, retail loans have declined from 30 per cent of the total loan book of Rs 25,800 crore in June 2006 to around 23 per cent of loan book of Rs.41,280 crore (as of June 2007). Even over a longer period, while the overall asset growth for Axis Bank has been quite high and has matched that of the other banks, retail exposures grew at a slower pace.
If the sharp decline in the retail asset book in the past year in the case of Axis Bank is part of a deliberate business strategy, this could have significant implications (not necessarily negative) for the overall future profitability of the business.
Despite the relatively slower growth of the retail book over a period of time and the outright decline seen in the past year, the bank’s fundamentals are quite resilient. With the high level of mid-corporate and wholesale corporate lending the bank has been doing, one would have expected the net interest margins to have been under greater pressure. The bank, though, appears to have insulated such pressures. Interest margins, while they have declined from the 3.15 per cent seen in 2003-04, are still hovering close to the 3 per cent mark. (The comparable margins for ICICI Bank and HDFC Bank are around 2.60 per cent and 4 per cent respectively. The margins for ICICI Bank are lower despite its much larger share of the higher margin retail business, since funding costs also are higher).
Risk and earnings perspective
Such strong emphasis and focus on wholesale corporate lending also does not appear to have had any deleterious impact on the overall asset quality. The bank’s non-performing loans are even now, after five years of extremely rapid asset build-up, below 1 per cent of its total loans.
From a medium-term perspective, it appears that Axis Bank could be charting out a niche for itself in the private bank space. It appears to be following a business strategy quite different from the high-volume and commodity-style approach of ICICI Bank and HDFC Bank. That strategy also has its pluses in terms of the relatively higher margins in some segments of the retail business and the in-built credit risk diversification (and mitigation) achieved through a widely dispersed retail credit portfolio. But, as indicated above, Axis Bank has been to able to maintain the quality of its loan portfolio despite the concentrated nature of wholesale corporate lending.
The key to the bank’s continued strength will be maintaining all the above metrics of performance — strong business growth on both the asset and liability sides, rigorous credit appraisals and monitoring, the ability to leverage on the wide and expanding branch network and a steady build-up of the retail banking franchise.
Domestic themes may help investors ride out the global volatility
What view should you, as investor, take on the intense volatility in Indian stocks? Well, there are two equally convincing answers.
Strong fundamentals
On one hand, the recent rout in Indian stocks has little do with the fundamentals of the economy or companies, triggered as it is by global factors (mainly fears relating to the US housing market). India Inc. continued to deliver strong earnings growth even in the just-concluded June quarter and growth drivers such as consumption and infrastructure spending appear to be strongly poised.
Companies in the Indian investment universe, except technology majors, also do not have a significant exposure to the US economy or its consumption trends and thus, their earnings may not be directly vulnerable to any US-related slowdown. This view suggests that the recent corrective phase could be a temporary one triggered by panic and that India’s strong fundamentals will eventually win over investors (both local and global). If this is indeed the case, any further declines in the coming weeks should actually be used to ferret out buying opportunities in Indian stocks.
Liquidity matters
However, the opposite view can also be argued with equal conviction. Yes, corporate India’s fundamentals are quite strong and may even be more resilient than those of other emerging economies. But a deluge of foreign investment in Indian stocks over the past four years has meant this fact is already well-known and is reflected in current stock prices. The recent correction notwithstanding, the stock market continues to trade at a premium valuation to other emerging markets.
What is more, while India’s companies do not depend heavily on the rest of the world for growth, its stock market certainly does. With a relatively low domestic participation in equities, it is the steadily increasing FII investments that have contributed in a major way to steadily spiralling stock prices over the past four years. For Indian stocks to resume their upward journey a continued flow of liquidity will be a pre-requisite. And recent global events definitely do have the potential to interrupt these liquidity flows.
In the past week, several non-US banks, financial firms and hedge funds have reported troubles from indirect exposures to mortgages/mortgage securities in the US markets. While debt funded M&A may be the first casualty, a ripple effect could draw in players such as hedge funds, international investment funds, global investment banks and private equity players, all active participants in the equity markets; this is bound to have liquidity implications for equities, especially in emerging markets such as India. This suggests that despite their fundamental attractions, Indian stocks could settle into a prolonged phase of listless or even downward moves.
Caution warranted
These factors suggest that, even if corporate fundamentals do seem positive, caution may be warranted in making fresh equity investments at this juncture. To start with, the decision on whether to indulge in a buying spree, or to simply remain on the sidelines now, should probably be based on the shape of the individual’s portfolio.
An investor who has a small or negligible equity exposure, but an appetite for risk, can use the corrective phase as a buying opportunity to peg up this exposure. But one who already has a significant equity allocation in his portfolio (relative to his preferred debt-equity mix) should probably consider staying on the sidelines. Replacing some poor portfolio choices with fundamentally sound stock ideas would also be a good move at this juncture, as it could help reduce the downside risk you carry.
Greater selectivity in stock and sector choices may also be called for while rejigging your portfolio. For instance, despite signs of recovery in this sector last week, it appears wise to limit exposures to technology stocks at present. Though the cap on external borrowings by Indian companies is widely expected to support the rupee, the jury is still out on whether this will be offset, over the medium term, by a falling US dollar or stronger domestic portfolio flows.
The significant exposure that large IT companies have to the global banking and financial services space, by way of clients/business, also suggests that it may be better to wait to gauge the impact of unfolding global events on IT company earnings. On the other hand, the earnings outlook for the domestic banking sector has certainly improved in recent times as the RBI cap on external borrowings last week may lead to stronger credit offtake for domestic banks, lending strength to earnings. However, bank stocks may still be vulnerable to a decline in valuations, arising from any global meltdown in financial stocks.
Given the uncertainties relating to the external environment, investment opportunities in companies with a strong domestic focus may deliver superior risk-adjusted returns for investors.
Domestic themes may pay
Companies focused on lifestyle or consumption driven sectors such as FMCGs, consumer goods or media offer one set of options.
For investors with a higher risk appetite, frontline stocks from the infrastructure and capital goods space (consensus is building that interest costs will not materially impede growth in these sectors), may present good investment opportunities. Phasing out any stock purchases over the next few weeks/months, to take advantage of stock price volatility, may be the best course to follow.
Defensive portfolio: Marico Industries, Glaxo Smithkline Consumer Healthcare, Indian Hotels, Monsanto India and 3M India — stocks that combine a low beta (tendency to move with the markets) with strong earnings growth prospec ts appear good options for conservative investors with a long investment horizon.
Aggressive portfolio: Bharat Electronics, L&T, Maruti Udyog, Idea Cellular and Sun TV — stocks which combine strong growth prospects with a high beta may be candidates for investors with a high risk appetite looking to build a long-term portfolio.
Some clues on global cues
If you flip to a business channel after 4 p.m. on a market day, chances are that a mysterious pair of words — Global Cues — will be flashing on the screen. “The fall in domestic stocks was on global cues arising from the belief that losses in the US mortgage market would impact the world’s biggest economy...” the anchor explains.
What constitutes these “global cues” and why do Indian stocks react to fears of a US recession or interest rate changes in Japan? Here are a few answers:
Why global cues?
The phrase ’global cues’ is a way of explaining the positive/negative effect of events in other markets on Indian stocks. Global cues have an impact on Indian stocks because of two factors. First, India’s financial markets and its economy have developed greater linkages with the rest of the world, as companies trade, expand their operations, acquire and borrow actively overseas.
Second, there has emerged a large class of global institutions and funds that dabble in and actively switch money between stocks, bonds and currencies from across the world. Such investors today play a key role in stock market movements.
As equity markets in Europe and the US mature, those seeking higher returns on their investments have made a beeline towards the emerging markets, India included. Foreign Institutional Investors have pumped in nearly $60 billion (over Rs 2.5 lakh crore) in Indian equities so far and are major stakeholders in Indian companies. As their radar is always on for the best investment opportunities worldwide, any change in interest rates or stock prices at any of the major global markets has a bearing on their investment decisions for India.
Tip: Don’t be content with knowing that ‘global cues’ caused a stock market slump. The trick lies in identifying cues that impact your stocks and sectors.
Events that matter
The following types of global events have, in the past, had a material impact on Indian stocks:
Interest rate changes in foreign countries — this determines whether borrowing money becomes cheaper or dearer. Keep a close watch on the US Fed/Bank of Japan/European Central Bank-related news.
Any appreciation/depreciation of major currencies against the rupee — US Dollar or Yen are most significant.
Spike in commodity prices and possible factors behind them — especially steel, crude oil and metals.
Trend in Asian markets (same day) and US markets (the previous day) — this determines the overall breadth as well as direction for the Indian markets.
Major announcements/statistical releases regarding the US market — mortgage market, economy, growth, inflation and their impact.
A Yen for trade
Large foreign investors borrow money in Yen in Japan and then invest in emerging markets, including ours. Suppose a US fund-manager borrows in Japan at the rate of $1=130 Yen and invests in Indian equities at $1 = Rs 41. The Indian stock markets have given a return of 16 per cent for the year.
Assuming the Yen depreciated against the dollar by about 7.7 per cent for the year and the dollar depreciated by 4.8 per cent against the rupee… this pegs the yearly returns for the fund-manager at 28.5 per cent (16 + 7.69 + 4.88) in Indian stocks!
This strategy, called “carry trade” is popular because an investor borrows a certain currency at a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate.
The Japanese interest rate has been hovering at less than 1 per cent for some time now (it was zero per cent for several years!). This effectively means that foreign investors can invest in Indian stocks using a relatively cheap yen and earn whopping returns.
The risk in this carry trade is the uncertainty about exchange rates. If the US dollar fell in value relative to the Japanese yen, then the US fund-manager would run the risk of losing money. When the Japanese currency gains strength against the US dollar, many of these traders may be forced to unwind positions, as they reportedly did in March this year.
Tip: Changes in interest rates have a direct bearing on currency movements. Major changes in the US dollar or the Japanese Yen can trigger volatility in Indian stocks.
Sub-prime woes and sub-par returns
The US sub-prime mortgage problem, cited as the reason for the recent stock price meltdown, tells you exactly why we should keep an eye on developments that have a global impact.
By definition itself, sub-prime mortgage loans are riskier loans made to borrowers who are unable to qualify under traditional, more stringent, criteria. This means these mortgage loans inherently carry a much higher rate of default (failure to pay up) than prime mortgage. So what prompts lenders to make funds available to these unreliable homebuyers?
The answer lies in a process called securitisation: where similar loans or mortgages (low-quality debt) are packed off as a negotiable security and sold off to firms.
Investment banks such as Bear Stearns and Merrill Lynch bought these loans from organisations such as Freddie Mac (nickname of Federal Home Loan Mortgage Corporation) to capitalise on higher interest rates without much effort.
Freddie Mac is a US Government-sponsored corporation that purchases residential mortgages and securitises them. Sub-prime mortgages totalled $600 billion in 2006, accounting for about one-fifth of the US home loan market.
All was going well until there was a cooling off in property prices and a steep rise in defaults by borrowers causing more than 20 sub-prime mortgage lenders to fail in the US. The failure of these companies caused the mortgage securities market to collapse.
With the fear that the mortgage crisis is growing bigger, an impending slowdown in the housing boom, and thus in the US economy itself, is a possibility. That is bad news for Asian economies and corporates, whose growth rates are hitched to a sustained boom in product and services exports to the US.
Tip: Markets often overreact to situations. When in doubt, delay investments.
Bad weather in Kuwait
Global changes in commodity (especially crude oil) prices hold considerable sway over stock prices because of their implications for corporate earnings. Factors such as lower oil inventories in the US or hurricanes in an oil-field can influence crude oil markets and escalate prices. This is important to stock markets not only from the point of view of refining companies, but also others.
A shortage of oil means higher fuel prices, which can cause a ripple effect on transport cost across sectors. Higher crude oil prices can also escalate input/raw material prices for oil-derived products and raise costs for companies that use them as inputs, trimming their earnings growth.
Tip: Understanding commodity price trends is important for stock market investing. Follow London Metal Exchange (LME) news if you are investing in the steel sector and New York/London WTI/Brent crude quotes for oil prices.
HEG: Buy
Investors with a two to three-year perspective can consider buying the stock of HEG (Rs 213), a leading manufacturer of graphite electrodes. Our recommendation is underscored by the management’s decision to hive-off its steel business and increase focus on the graphite and power businesses, which enjoy higher profitability. The decision appears positive, given that the steel business was incurring a loss and was a drag on the company’s profitability.
With an increased focus on its core operations, HEG is likely to benefit from expansion in its margins. In this context, the healthy demand outlook for graphite electrodes lends confidence.
At the current market price, the stock trades at about nine times its likely FY-09 per share earnings on a fully diluted basis. Investors can, however, consider buying the stock in lots given the volatility in the broad markets.
Revenue growth will hinge on the performance of the graphite division. In this context, a healthy order-book position, with about 80 per cent of the graphite electrode capacity pre-booked at 20-22 per cent higher realisation lend visibility to the division’s revenue growth. Moreover, with additional capacities expected to be operational by the last quarter of FY-08, revenues could get a further fillip.
HEG is also likely to benefit from the proposed setting up of a 33 MW captive thermal power plant, given its energy-intensive operations. Notably, the project cost for this plant, pegged at about Rs 80 crore, is at a significant discount to the industry benchmark. HEG could credit this discount to the setting up of sufficient infrastructure support when it had commissioned its previous plant.
The hive-off is also likely to benefit HEG by way of improvement in overall margins and profitability. The steel unit had, for the year ended FY-07, incurred a loss of about Rs 4 crore at the PBIT level (profit before interest and tax). Also, given that traditionally the unit has only enjoyed margins of about 6-8 per cent, as against the graphite and power divisions, which operate at about 23-28 per cent and 45-48 per cent margins respectively, overall margin expansion appears likely. This apart, with sale proceeds from the steel unit intended for retiring debt (about Rs 100 crore); the company could also gain from the strengthening of its balance sheet. This move, apart from getting the debt-to-equity at optimum levels, will also lead to a significant dip in interest cost.
Another notable advantage of the divestment is the lower susceptibility of HEG towards volatility in steel prices. While the volume growth in steel production through the EAF route (electric arc furnace) will continue to drive demand for graphite electrodes, steel price volatility is less likely to influence the overall earnings.
Robust performance
The company has reported strong numbers for the quarter ended June 2007. While sales grew by about 22 per cent on a year-on-year basis, earnings, helped by ‘other income’, grew more than two-fold to about Rs 28 crore.
While there was a 1.5 percentage point expansion in margins, there was a six-fold increase in ‘other income’ contribution due to forex fluctuations.
In the light of a volatile rupee outlook and given that the ballooning of ‘other income’ was mainly due to rupee appreciation, contributions from this segment could remain uneven. Earnings, however, could get a lift from a better business mix, a stable input cost scenario and the likely reduction in interest cost.
Dish TV: Buy
Investors with an appetite for risk can consider an exposure in Dish TV with a three-year horizon. Since its listing in April, the stock has cooled off considerably and is now trading about 35 per cent lower than its May high. The market appears to be factoring in a slower pace of subscriber additions on the back of more entrants into the Direct-to-Home (DTH) market and higher customer acquisition costs due to intense competitive activity. However, at the current market price of about Rs 86, much of these concerns appear to be factored in.
Stock outlook
Dish TV is the leading private DTH operator with 2.1 million subscribers and a first-mover advantage. As the only listed DTH play, the company’s stock is likely to remain on the investment radar of institutional investors. The stock may be the first to benefit from upside triggers such as an extension of CAS (conditional access system) to cover Delhi, Mumbai and Calcutta completely (expected to be implemented by January 2008) and to other cities as well as it would force cable and satellite homes to actively explore digital options. Similarly, any move to allow DTH operators to offer exclusive content would be positive as content will become the differentiator between players; presently low entry costs play that role. Such a move, while it appears some way off for now, will be a trigger for re-rating.
In the absence of these triggers, we expect modest returns over a one-year period, as Dish TV is likely to turn profitable only by 2009-10 and is, therefore, more suitable for the long-term investor. Fiscal 2008-09 might prove to be the crucial year for Dish TV when the full impact of the entry of three more players in the DTH market — Reliance Blue Magic, Sun Direct and Bharti— will be felt. While the competition is formidable, Dish TV’s first-mover advantage and the ability of the large Indian market to accommodate more players inspire confidence. However, a close monitoring of subscriber additions and customer acquisition costs relative to competition is required, as they would reflect the impact of competitive pressures on performance.
Market leader, for now
Although Dish TV continues to be the leading private operator competitor Tata Sky has given it a run for its money since its launch in the second-half of 2006. The latter has garnered a subscriber base of one million in the one year since its launch, a much faster pace than Dish TV did in its initial years. However, at least part of the speedier ramp-up by Tata Sky could be attributed to good timing of its entry into the market. Within a few months of its launch, CAS was implemented in the three metros and with a big event such as World Cup Cricket round the corner customers were far more receptive to Tata Sky’s promotional and advertising blitzkrieg. Dish TV until a year ago also suffered limitations on the content front with the Star bouquet of channels coming under its fold only shortly before the launch of Tata Sky.
Dish TV added 180,000 subscribers in April-June quarter and expects the additions to be significantly stronger in the second and third quarters, as the summer quarter tends to be typically a lean one. According to Dish TV’s estimates, the market saw 300,000 subscribers added during the period. It is likely to finish the year with close to three million subscribers, if it continues to retain its market share of incremental subscribers.
Competition to intensify
However, competition is likely to be intense, as new players with deeper pockets enter the fray. Even at the global level, the market has been won by those prepared to take losses for five-seven years and potential entrants such as Reliance Infocomm and Bharti Airtel (which has just received approval to start its DTH operations) are no strangers to the concept.
As regulations do not allow broadcasters to offer content exclusively to any one operator, content will not be a differentiator between the players; they will be forced to resort to heavy subsidising of set-top boxes and constant promotional activity to acquire customers. Dish TV runs the risk of increasing its customer acquisition costs to get additional subscribers; at Rs 1,800 per subscriber such costs are already at about seven-eight months worth of ARPUs (average revenue per user). Dish TV’s ability to cap acquisition costs at near current levels and sustain its lead over its competitors depends on how much the entry of more players expands the DTH market. The DTH market is projected to grow at a compound annual growth rate of 35 per cent through FY-15.
ARPUs to climb?
While steadily declining tariffs have helped expand the telecom market, the industry does not foresee a similar trend in the DTH market. For one, India’s DTH ARPUs (average revenues per user) are already among the lowest in the world at about $5 a month. This is the amount paid by the average mobile phone subscriber in India and is also equivalent to the current tariffs charged by cable operators. Second, the management at Dish TV reckons that, unlike telecom, the running costs of DTH operators are considerably higher, due to content costs. Broadcasters are unlikely to accept a lower price for their content until DTH manages a significant penetration of cable and satellite households. Operators are more likely to resort to promotional packages, luring customers with starter packs and then getting them to upgrade to higher end packages. As demand for value-added services such as video-on-demand and interactive TV improves over the long-term, the tariffs for the industry as a whole are likely to improve.
In the near-term, promotional strategies such as a free initial period of subscription are likely to rein in growth on the ARPU front. We, however, expect Dish TV to report better ARPUs over the next few years. Dish TV’s early customers paid significantly lower rates as the operator had earlier offered only limited content. As these customers migrate to higher tariffs, Dish TV expects to finish the fiscal with an ARPU of Rs 207. This is set to grow as its penetration in the metros increases and customers opt for higher end packages; only about 60 per cent of its subscribers belong to the top 100 cities.
Also, incremental subscribers as a percentage of the subscriber base are likely to decline over the years, which will reduce the impact of promotional activity (such as free subscription for initial months) on ARPU.
Investors may have to brace themselves for some equity dilution as well. Dish TV is likely to spend Rs 1,000 crore, funded through a mix of debt and equity over the next two to three years towards procurement of equipment and operations. However, with competition set to scale up (with Tata Sky also announcing plans to invest Rs 2,000 crore over three to five years), these investments will be necessary for Dish TV to protect its turf.
Areva T&D: Buy
Investors with a two-three year perspective can consider adding the Areva T&D India (Areva) stock to their portfolio, as the company is likely to emerge as one of the key beneficiaries from the continued investments in the power sector. Strong support from its French parent and expansion plans are factors that will enable the company to capitalise on imminent opportunities.
At the current price, the stock trades at 26 times its expected earnings for calendar year 2008 (CY 2008). With very few local competitors in the segment in which it operates, and the high growth visibility that the power equipment sector offers, the company is likely to sustain premium valuations. Investors can make use of any declines in the stock price linked to the broad markets to accumulate the stock.
Areva has started its expansion process with the setting up of two greenfield projects consisting of high voltage power and instrument transformers. It also has plans to further expand its product range and double its current capacity over the next couple of years. The proposed projects may not only help the company capture domestic orders, but also secure orders from its parent and other Asian companies. Areva, at present, contributes to about 10 per cent of its parent’s order intake. The interest evinced by the parent in the Indian arm is in line with the trend seen in companies such as ABB and Siemens. In this backdrop, we expect Areva to gain more business through its parent, given the cost advantage that the Indian unit enjoys.
Areva is in the process of merging three group companies. This is likely to result in more integrated operations, as all the T&D businesses would come under one roof. The merger is likely to be earnings accretive, with marginal equity dilution. Areva’s stronger thrust on the T&D business has been evident since its exit from non-core businesses last year. The benefits of this in terms of profitability are clearly visible as the operating profit margins for the quarter-ended June 2007 increased by 300 basis points to about 15.5 per cent. Net profits also surged by 55 per cent.
Any business opportunities in India arising from the parent’s strength in nuclear power projects, could provide additional upside, though they have not been factored in, pending clearance of India’s civilian nuclear deal by International agencies. Any business from the same would accelerate earnings growth. A sharp slump in order book levels and hike in raw material costs remain principal risks.
Selling pressure stays
If the markets follow the Friday’s cues from the US market, the BSE Sensex and the S&P CNX Nifty are likely to consolidate or may see a relief rally, unless the Asian markets provide some negative cues on Monday. At a higher level, selling pressure will come and markets may see a downside.
The US stocks recovered from a global sell-off, erasing most of the Dow Jones’s 213-point drop, closing 31 points down on Friday as the US Fed and central banks of Europe, Japan, Australia and Canada pumped huge amount of money in their banking systems to avert a credit crunch.
The outlook appears to be guarded as the markets are trading below their support level at 4,500, and a possibility of 4,200-4,220 levels loom if persistent selling occurs. The Nifty near-month futures traded at Rs 34.15 discount to cash market compared with Rs 35.20 in the previous weekend. The basis is pointing towards a lower risk appetite as the markets move downwards. The downward bias continues.
Marketwide open interests have gone up slightly to Rs 84,000 crore. The Nifty will find resistance at 4450 and a short term support exist around 4200-4220. Put-call ratio (PCR) is 0.31:1. The total PCR has remained below the equilibrium point of 0.50 : 1.
This scenario indicates that market will remain bearish as short positions exist.
Investor's Eye dated August 10, 2007
Telecommunication
Record net adds
The GSM (global system for mobile communications) operators added 5.75 million subscribers in July 2007--that is higher than 5.38 million added in June 2007. This amounts to a growth of 4.2% (to 141.7 million subscribers) over the base of 136 million at the end of June 2007.
FMCG
Q1FY2008 earnings review
Companies from the fast moving consumer goods (FMCG) sector have reported an impressive performance for the first quarter of FY2008. On an average, the top line and bottom line of the FMCG industry grew by 17.5% and 20.6% respectively during the quarter. In spite of the rising pressure of high raw material prices, the industry was able to maintain its margins in Q1 and this was a positive surprise. The revenue growth was driven by higher volumes and improved pricing power. The strong growth in the revenues of companies like ITC (despite price hikes and declining volumes), Hindustan Unilever Ltd (HUL), Dabur India and Nestle indicates that the performance of the sector would be strong in the coming quarters.
Cement
Top three majors register a superlative dispatch growth
The top three cement majors registered a superlative dispatch growth in July. ACC's dispatches grew by 15.2% year on year (yoy) to 1.64MMT (million metric tonne) led by the higher capacities at its Lakheri and Kymore plants. Ambuja Cements recorded the highest dispatch growth of 19.5% yoy to 1.39MMT, whereas the AV Birla Group registered a dispatch growth of 13.1% yoy to 2.4MMT. We believe the growth looks inflated as most parts of India witnessed heavy monsoons in July last year. This is substantiated by the fact that the month-on-month decline in dispatches for July last year is very steep compared with that of the current year.
MUTUAL GAINS
Sharekhan's top equity fund picks
We have identified the best equity-oriented schemes available in the market today based on the following 3 parameter : the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).
The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.
FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager
Investor's Eye dated August 10, 2007
Another Crazy Ride
Monday started on a weak note. The sentiment was lifted on Tuesday and Wednesday. US shares rallied on Wednesday, with the Dow Jones Industrial Average registering a triple-digit gain after Cisco raised its sales forecast and concerns eased on the crisis in the sub-prime mortgage and credit markets
On Thursday, the markets opened strong but could not sustain the momentum. BNP Paribas, France's biggest bank, said that it had temporarily suspended redemptions in three of its funds due to the current turmoil linked to the US sub-prime mortgages. Weakness in the European markets and selling in the index heavyweights like SBI, L&T and RIL dragged the benchmark Sensex to hit a low of 15,062.
Friday did not bring any good cheer. The US sub-prime mortgage worry hit the European markets, the US markets and the Asian markets.
When looking at the closing prices on August 3 and 10, 2007, only 8 of the Sensex stocks closed in the green. And 4 of them were tech stocks: TCS (4.41%), Wipro (2.13%), Infosys (1.71%) and Satyam (1.60%). The biggest losers were Hindalco (-6.93%) and ICICI Bank (-5.42%).
Various sectoral indices dropped on Friday but BSE IT Index rose to close at 4774.13. Realty, banking and metal stocks were the worst hit on Friday.
SBI had a volatile week with reports that the government is expected to fund the bank's growth plans and then news that the bank may split its stock as it sells shars to raise funds.
Realty stocks picked up at the start of the week and BSE Realty closed at 7540.55 on Wednesday. But due to profit booking towards the end of the week, it closed at 7263.54.
Weekly Newsletter
Global meltdown...this time the French Connection
Just when the global investors were beginning to think that the storm had passed came a fresh round of bad news on the growing pain from the subprime mortgages in the US. Markets around the world tanked on the last two days of the week after French bank BNP Paribas said it had suspended redemptions and valuations in three funds with exposure to the US subprime mortgages, citing lack of liquidity. US insurance giant AIG too warned that the malaise of subprime mortgages could be much deeper and wider than anybody ever thought. Countrywide Financial Corp., the largest US mortgage lender, said a prolonged period of poor conditions "could have an adverse impact on our future earnings and financial condition." To calm nervous investors and tide over the liquidity crunch central banks in Europe, US, Canada, Japan and Australia injected cash into their respective banking systems. The ECB actually did it for two successive days.
Though the pressure on overnight rates eased, the moves were not enough to stem the carnage across equity markets. The Dow Jones had its second worst day of the year, sinking by 387 points on Aug. 9. Key European markets in Germany, France and the UK lost 2% each. Emerging markets were not spared either with the Bovespa in Brazil tanking 3.3%, the RTS index in Russia crashing 2.4% and the ISE National-30 index in Turkey plunging 4.2%. The next day, Asian markets collapsed with the Nikkei in Tokyo and the Hang Seng in Hong Kong losing 2.4% and 2.9% respectively. Australia's S&P/ASX 200 slumped 3.7% to 5,936, South Korea's Kospi dived 4.2%. India's BSE Sensitive index staged a remarkable recovery from the lows of the day to close down 1.5%.
Looks like the turbulent times may last for a while before some stability and sanity returns to markets. Following the warnings from BNP Paribas and AIG, investors are now worried which part of the world the next bad news is going to come from. Right now nobody seems to have a clue how deep this contagion is and how long it will take for the global markets to get over this crisis. For now though, one can only wait and watch the mess unfold.
Govt unveils fresh ECB curbs
Even as the central banks across the world scrambled to boost liquidity and help banks deal with the cash crunch, here in India the Government and the Reserve Bank of India (RBI) were busy doing the opposite. The central bank announced new norms for overseas borrowings to prevent the relentless flow of foreign money from pushing inflation and the rupee higher. Restricting the use of foreign borrowings for domestic expenditure had been one of the measures recommended by the Prime Minister's economic advisory council headed by Dr C Rangarajan last month, to insulate the economy from excessive capital inflows.
As per the revised ECB norms, companies will now be able to raise only up to US$20mn abroad for rupee expenditure and that too with prior approval from the RBI. This means, companies can raise a maximum of Rs800mn abroad via debt for domestic expenditure. For the rest, they will have to look for local financing. Such funds cannot be brought into India until actual requirement in India, the RBI said. All ECBs above US$20mn will be allowed only for foreign currency expenditure for permissible end uses. This restriction will be applicable to ECBs permitted both under automatic route as well as approval route. ECBs up to US$20mn for foreign currency expenditure can be availed for permissible end-uses under automatic route.
All other aspects of ECB policy such as US$500mn limit per company per year under the automatic route, eligible borrower, recognised lender, average maturity period, etc remain unchanged. The new rules will not be applicable to borrowers who have already entered into loan agreement and obtained loan registration numbers from the RBI. Also, borrowers who have taken verifiable and effective steps, wherein the loan agreement has been entered into to avail of ECB in the previous dispensation, and not obtained the loan registration number, may apply to RBI.
Bulls run for cover amid global selloff
There’s a place so dark you can’t see the end…
a spot of light floods the floor
The market was extremely volatile this week as the bulls had a tough time charting their course for the future amid continuing concerns over the US subprime mortgage crisis and its impact globally. IT stocks made a comeback following the tightening of ECB norms and Fed's soothing remarks on the state of the US economy. However, soon the drive turned rocky for the bulls, as concerns mounted about the wider fallout of the slump in the American housing market. New evidence emerged that the subprime mortgage contagion in the US was spreading to other regions of the world.
Markets across the globe sank after French bank BNP Paribas said it had suspended redemptions in three funds with exposure to the US subprime mortgages. US Insurance major AIG too warned about the subprime mortgages and the largest US mortgage lender said a prolonged period of poor conditions could have an adverse impact on future earnings and financial conditions.
As a result, the key indices wiped off early gains of the week to close lower. The benchmark BSE Sensex lost 270 points or 1.8% to close the week at 14868 and the NSE Nifty fell 1.5% or 68 points to close at 4333. However, some value buying was seen on Friday in IT stocks, lifting the key indices from the one-month lows. Otherwise, it could have been much worse. Only, IT stocks survived the carnage, which took all the major sectoral indices deep into the red.
IT index stood firm in this volatile week after IT the tightening of ECB norms, which will result in lesser dollar inflows. Also, over the week, Rupee lost some ground against the US Dollar closing at 40.62. The revised ECB norms could prove good for export-centric sectors like IT and Textiles in the near term. Rupee had its biggest weekly decline in two months following a sell-off in local equity markets amid growing concerns U.S. subprime mortgage issue could spread to different regions. Index heavyweight TCS rose by over 4.5% to Rs1145, Wipro advanced 2.1% to Rs480, Infosys was up by 1.7% to Rs1952 and Satyam added 1.6% to Rs471. HCL-Tech rallied by over 7% to Rs319.
Metal stocks were among the major losers over the week, as a sell-off in LME got the better off the Metal stocks on Dalal Street. Also, the tremors of Subprime issues were also felt among the global metal prices. BSE Metal index fell by 4.1% during the week. JSW Steel fell by over 7.5% to Rs627, Tata Steel was down by 2.6% to Rs634, Sterlite Industries lost over 5.5% to Rs592 and Hindustan Zinc slipped 1% to Rs710.
Exposure to credit market was the talking point for the banking & Financial service stocks. Concerns grew among investors on Banks exposure to US sub prime market. Index heavyweight ICICI Bank was the second biggest loser among the 30-scriop’s of Sensex, it fell by over 5.5% to Rs864, HDFC Bank was down by 2.1% to Rs1130 and SBI declined 1.7% to Rs1606. While, Corporation Bank, Kotak Bank and Syndicate Bank were the major losers among the Mid-Cap stocks.
Profit booking was seen in FMCG stocks. Hindustan Unilever slipped 4.4% to Rs195, Tata Tea lost 4.6% to Rs695, ITC declined 3.5% to Rs163, Nirma was down by 3.5% to Rs162 and Britannia dropped 2% to Rs1599.
All eyes on global markets
"If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem."
The problems are a plenty and when the woes set in, it appears we have just scratched the surface. The movements of global markets have become an important part of the Indian indices. Things have been extremely choppy over the past few trading sessions. Expect another Manic Monday as global cues may well point to a weak opening. It may take a miracle on Wall Street to resurrect the hopes of bulls across the globe. Any bounce back should be used to pare your exposure to the equity market for the short term. Long term investors can remain invested and watch the show from the sidelines. U.S. Securities and Exchange Commission is checking the books at top Wall Street brokerage firms and banks to make sure they aren't hiding losses in the subprime mortgage meltdown. Another choppy week is in store.
Mutual funds: Everybody`s darlings
Once upon a time it was Reliance Industries (RIL). Then Infosys Technologies joined the bandwagon. And now, Bharti Airtel is the latest addition. The darlings of the mutual fund (MF) fraternity seldom change.
In a raging market where valuations may appear stretched, index stocks continue to dominate the 'buy' list of every fund manager. It seems that fund managers seem to hold some portion of their portfolio in index heavyweights to avoid missing the market rally by a wide margin. So, even when profit-booking takes place in these counters, mutual funds continue to hold at least some of these shares.
Reliance Industries is a classic example. One can't say the same for mid caps though. Fund managers' favourite mid-cap holdings change rapidly. The latest ones that are dominating the holding charts are Crompton Greaves, United Phosphorous and Cummins India.
It's not difficult to figure out why these stocks dominate the list. As the equity market continued to rise, retail interest in equities surged as well. Many MFs, which were flush with cash raised through their new fund offerings (NFOs) - had to plough in this cash somewhere.
Hence, companies which already had proven track records appeared to be safe bets. So, more money was pumped into these darling stocks. This is evident from the fact that the total number of shares of these companies with mutual funds has surged significantly as market valuations turned ripe. The Sensex was trading at 20 times historical earnings at the beginning of July '07, and 21 times historical earnings as in June '07.
A sustained rise in corporate earnings aided the surge in the Sensex. However, the Sensex has been trading above its historical averages. With the India Growth story intact and excess liquidity in the market, the demand-supply mismatch of quality stocks pushed up premiums.
So, the price of safe counters such as Reliance Industries shot up from around Rs 1,400 to Rs 2,000 levels, while Bharti Airtel and Crompton Greaves stocks have almost doubled in the past three-to-four months.
Technology and financial services are the most sought-after sectors, with Rs 22,000 crore and Rs 14,500 crore worth of share investments, respectively, as in June '07. The mutual fund industry has grown rapidly in the past few years, and this is evident from the rise in the assets under management (AUM).
According to the Association of Mutual Funds in India (Amfi), the AUM of mutual funds has increased 52% in the past one year to Rs 400,842 crore in June '07 from Rs 263,949 crore in June '06. To a large extent, retail money has been invested in equity mutual funds. Equity savings as a percentage of total financial savings has also moved up significantly.
Though the latest collated data is not yet available with the Reserve Bank of India (RBI) and Central Statistical Organisation (CSO), this figure is understood to have moved up from around 2% to more than 6% as of '06.
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