Sunday, October 07, 2007
When Federal Reserve Chairman Ben Bernanke announced the hefty cut in interest rate in August he had also indicated that the downside risk to growth had increased considerably. Since then, the trends have worsened making recession in US almost imminent. Alan Greenspan put a date on it. It is possible we can get a recession in the later months of 2007, he said, though most forecasters expect it in 2008. The reason why Greenspan feels recession may descend early is that profit margins of US companies have begun to stabilize. Besides, in August more than 4000 employees lost their jobs. Recession will be the cumulative effect of sub-prime mortgage crisis and housing burst.
The US economy has been expanding since 2001 and is now almost at the end of the cycle. An economy is in recession when economic growth becomes negative for at least two consecutive quarters. Since the US recession will be brought about by housing burst it is likely that the drag on the economy will continue for a much longer time. Japan took nearly a decade to normalize from a similar shock. Recession in the US is a concern for the rest of the world because the US is the largest economy generating more than 28 per cent of the world GDP and absorbing 16 per cent of world imports.
The country''s BPO sector will continue to face the brunt of the appreciating rupee which will hit margins by 0.2-0.5 per cent in the coming quarters, top industry players today said. ''''BPO and small companies are likely to bear the brunt of rise in rupee in comparison to bigger software firms as they are working on strategies and have additional levers to reduce the impact on profitability,'''' Nasscom Chairman and Cognizant Technology Solutions Vice Chairman Lakshmi Narayan said.
To help offset the impact, government should extend the STPI scheme to such companies just like other export oriented units, he added. The industry is continuously evaluating the impact of the rising rupee, outgoing Nasscom chief Kiran Karnik said, adding that there is no impact on Indian IT companies topline but for every one per cent change in rupee there is 20-25 basis points (bps) change in profitability. ''''The BPO industry will be strongly hit,'''' he added. The bigger companies are managing to offset the rupee impact through their operational efficiency and gain in supply, Kanrnik said. The supply side is improving and there will be a moderation in the wage structure from next year which in turn will help improve the situation, he added. ''''The government have been very supportive and has played a active role in taking IT industry to heights,'''' newly appointed Nasscom chief Som Mittal said, adding that India will become a knowledge capital of the world.
Reliance Power 60 to 80 34 to 35
Dhanush Tech. 295 90 to 95 (Good comeback, IPO is now about 18 times oversubscribed, Can't guarantee the listing price though)
Koutons Retail 415 75 to 80
Consolidated Construction 510 200 to 205
Supreme Infra 108 55 to 58
Saamya Biotech 10 5 to 6
MAYTAS Infra 320 to 370 135 to 140
Circuit Systems (India) Ltd 35 5 to 6
The US job-creation machine kept cranking during the mid-year credit squeeze -- despite fears of a stall a month ago -- prompting analysts to once again tear up their forecasts for the US economy.
Friday's Labor Department report on nonfarm payrolls showed 110,000 new jobs created in September.
But the big surprise was the revision to the estimate in August: the government now estimates a gain of 89,000 jobs, instead of a net loss of 4,000.
Just as last month's data had stunned analysts and fanned fears about a downturn, the revision has prompted economists to upgrade their forecasts.
"Oops, they did it again," economist Avery Shenfeld at CIBC World Markets said of the hefty revision.
"Remember that ominous payrolls decline for August? It now shows up as a gain of 89,000. So as far as being in recession already -- nevermind."
The big revision for August was nearly all in local education, which the Bureau of Labor Statistics says can be "volatile" in the summer and had a small survey response.
Shenfeld said he is now redrafting his outlook based on the jobs report, seen as one of the most reliable gauges of economic momentum.
"We had been giving thought to a downward revision to our just-under-1.0 percent real growth forecast for the fourth quarter," he said.
"But this revised picture of the labor market suggests that even with weakness in industrial orders and housing, there will be some support for growth from consumers."
Last month's original report showing the first drop in overall employment in four years was seen as a factor in the Federal Reserve's decision on September 18 to slash key interest rates by half a percentage point.
Now after the revision, the Fed faces a fresh conundrum on whether to cut rates further, or wait until they see if the economy pulls out of a soft patch on its own.
"Would (Fed chairman) Ben Bernanke and the crew at the Federal Open Market Committee cut rates 50 basis points without a negative print on the jobs? I seriously doubt it," said Andrew Busch, an analyst at BMO Capital Markets.
Busch and others said there are now doubts about future rate cuts, especially as credit markets appear to be returning to normal.
"Further rate cuts are now significantly in doubt," said Stephen Gallagher, an economist at Societe Generale.
"In as much as the Fed reacted to the one number, the move may have been an overreaction. The Fed will remain very sensitive to financing conditions, but any additional rate cuts are now in jeopardy."
Robert MacIntosh, a chief economist for Eaton Vance, said the revised data suggests the central bank may have erred in easing rates so much.
"It means the Fed probably shouldn't have done what they did, that they should have waited," MacIntosh said.
"Those of us who were skeptical at the time now feel a little redeemed."
MacIntosh said the latest data is consistent with economic growth in the two to three percent range, above the level of one to two percent most had estimated ahead of the latest data.
"The economy's doing fine despite all the housing headlines," he said.
Others say the report paints a picture of an economy that is sluggish and still faces risks. Some say the economy needs to create 100,000 to 150,000 new jobs each month just to absorb new labor market entrants.
"The recent pace of job growth is insufficient to prevent the unemployment rate from increasing further," said Robert DiClemente, an economist at Citigroup.
The figures "reveal a clear softening in underlying labor market conditions that likely will reinforce the current moderate economic growth track."
Economist Nigel Gault at Global Insight said he still expects the Fed to cut rates by another half-point, but the timing is less clear now.
"Our underlying view of the economy remains unchanged," he said.
"Output growth is slowing, employment growth is slowing, and the Fed will need to cut interest rates further ... But whether the next rate cut will come as soon as (the next Fed meeting) October 31 is now in question."
Emerging markets equity funds absorbed over $5 billion for the second consecutive week, but the fund flow pattern also indicated that investors were beginning to get cautious, according to Emerging markets Portfolio Funds Research.
Money Market, Balanced, Global Equity and US Bond funds all took in fresh money, and there was a clear shift within US equity funds in favour of Large Cap Value funds. Consumer Goods sector funds had their best week in over three years.
“Despite the hints of higher risk aversion during, this year’s story is clearly the accelerating shift by investors out of funds geared to the major developed markets — the US, Japan and the Eurozone — and into those focusing on emerging markets,” said EPFR Global Analyst Cameron Brandt said in his weekly note. “When you look at the numbers through the first three quarters of this year and 2006 the retreat from Japan and Europe Equity Funds is particularly striking,” the note added.
Asia (excluding Japan) and the diversified Global Emerging Markets (GEM) equity funds accounted for the bulk of the flows into emerging markets funds during the first week of October, taking in $2.87 billion and $1.84 billion respectively.
China was the favourite with country-specific investors, while flows into BRICs (Brazil, Russia, India and China) equity funds hit a 39 week-high in terms of percentage of assets under management.Korea, which has the biggest average country weighting among GEM Equity Funds, too continued to find favor with investors, with Korea country funds posting their 21st week of net inflows.
Flows into Latin America Equity Funds slowed but remained positive, with Mexico country funds taking over from their Brazil counterparts as a driver of inflows.
BRICs equity funds continued their recent rally, taking in a net $434.6 million for the week. Year-to-date, however, they remain well off the pace they set in 2006. And, with the exception of Brazil, the same was true for the funds geared to the individual BRIC countries.
EMEA (Europe Middle East Africa) equity funds had their best week since late July thanks in part to an influx of fresh money into South Africa country funds.
Despite posting their best weekly performance since the third quarter of 2006, Japan equity funds recorded their 27th consecutive week of net outflows. Investors are still concerned that the Bank of Japan (BOJ) will push ahead with its stated intention of normalizing interest rates, thereby undercutting an extremely fragile recovery in domestic demand and fueling an appreciation of the yen that will cut into export earnings. Japan’s central bank will meet on October 11.
The euro’s relentless appreciation against the dollar, and the implications that has for Eurozone exporters, is also weighing on investor sentiment towards Europe. They pulled another $1.22 billion out of Europe equity funds, pushing total outflows since the beginning of June over the $17 billion mark.
The global credit squeeze also appears to have pushed European economic growth onto the downward part of the growth cycle, with consumer and business confidence indicators dropping sharply in recent weeks.
The Dalal Street is expected to witness a positive bout in the week ahead amidst the volatile environment on the bourses driven by global cues even as the 18,000 milestone remains just within the reach, analysts have said.
“Bulls have had a fantastic time so far on Dalal street in the wake of the Fed’s better than expected rate cuts and unabated FII inflows into the Indian equity markets,” domestic brokerage India Infoline said in its weekly wrap.
However, choppiness and sharp swings around these levels are expected ahead of the quarterly results, it added.
The BSE benchmark index Sensex closed at 17,773 points, adding over 400 points in the previous week while remaining within the kissing distance of the 18,000 milestone. It had also touched an intra-day new peak of 17,979.18 points on 5 October.
Analysts also believe that an upswing may be witnessed this week as the US Labour Department data has showed hike in the number of jobs. The US stock markets had shot up in opening trades on Friday after the Labour Department said the economy added 110,000 jobs.
The experts also believe that the stock markets may see an upside in the coming sessions, with stock-specific action based on corporate results, although certain amount of profit booking cannot be ruled out.
“Quarterly results will start coming in this week and they can be a reason to be exuberant or disappointed,” Arun Kejriwal of Kejriwal Securities said.
Factors that would predict market trend in the coming weeks include quarterly results from Infosys and the board meeting of DLF on October 11 to consider overseas acquisitions and raising funds offshore. This would be followed by quarterly results from HDFC Bank and Reliance Industries annual shareholder meeting on 12 October.
“The domestic trigger for the market could be the political standoff regarding the nuclear deal....it would be healthy if the markets would consolidate in the range between 17,000 to 18,000,” Asika Stock Brokers’ Paras Bodhra said.
Foreign institutional investors are favouring the Asian markets, especially China and India, he added. FIIs have made net investments in equities worth Rs9,425.80 crore in just five days till 5 October, while they have bought Rs60,592 crore in 2007 so far.
Besides, domestic mutual funds have sold off equities worth about Rs 532.50 crore in the first week of the month. An increase in annual inflation, based on the wholesale price index (WPI), which moved up 3.42% in the week ended 22 September from 3.23% in the week ended 15 September, doesn’t appear to be a welcome sign, experts said.
The rise in inflation is due to increase in prices of manufactured products, with a 63.75% weight in WPI. Food products like salt and oil became dearer in the week.
More expensive food is the mega trend of 2007. There are six billion people on this earth. And it may be safe to say that this year there would be hardly any one who can claim to be unaffected by the rise in price of wheat, rice, corn, pulses, vegetables, milk, meat, eggs and cooking oil.
This mega trend has already led to two tectonic shifts in global agricultural trade in the last few months. One, except for sugar, the days of dumping food on the world market are over. Two, governments of every political hue and religious colour are unapologetically making radical changes in trade policy to keep local food prices within sane limits.
Let’s take dumping first. Dumping is selling a commodity below its cost of production. For several years now the large exporting nations have kept world prices artificially low by hefty subsidies to local farmers. The ways of dumping have been fairly ingenious.
The USA’s food aid, for instance, is the sushi equivalent of a dumping programme wrapped in the cloak of charity. The USA gives more than half of the world’s nearly $4 billion of annual food aid. Yet by law, the US Agency for International Development and other federal agencies can’t simply write cheques to feed the hungry. Instead, they must buy American-grown food from American conglomerates; 75% of it must be shipped on American-flagged vessels. It’s been a sweet deal for domestic businesses and creates a ready market for local farmers.
What’s more, these food shipments are often given to NGOs in poor countries, which sell them to raise money. In the last three years alone, these groups have reportedly sold off $500 million of American food aid.
But high grain prices are rapidly puncturing USA’s enthusiasm for charity. In 2004, USA paid around $363 to buy a tonne of food aid and ship it to the developing world, officials say. This year, delivering that same tonne of aid abroad will cost an estimated $611, an increase of 68%. In fact, food donations to the world’s hungry have fallen to their lowest level since 1973 as surging grain and shipping prices outpace the aid budgets of rich nations.
The virtual disappearance of dumping is great news for farmers across the world who can now expect to receive the real price for their crops from the world market. Unfortunately, the downside is that for the world’s 850 million hungry people, often concentrated in countries ravaged by war and famine, the decline in food aid also means plunging further into hopelessness.
While charity is rapidly going out of fashion, changing rules of the game is certainly in. Just to give you an idea, here is a short list of policy changes around the world in the last one month. Whether they are successsful or not, governments are desperate to be seen as being proactive.
With elections in December, the Russian government intends to limit wheat exports, release stocks to keep domestic wheat prices down, and impose export tariff on barley. Pakistan has banned wheat imports and decided to import 1 million tonnes. Thailand has reduced import duty for chickpeas, beans and pulses from 30% to 5%, and for wheat from 0.10 baht/kg to zero. Indonesia has liberalized rice imports by state-run Bulog. Though the world’s largest export of palm oil, it has imposed a stiff tax on palm oil exports and exempted non-branded cooking oil from VAT to keep local prices affordable. Current cooking oil retail prices are 41% higher than in January 2007.
A strike by bakers to protest high wheat prices in Nigeria has forced the government to sit up. Even in oil-rich Saudi Arabia, the 60% rise in basmati prices has forced the government to clamp down on MRP.
In Tunisia, there is growing alarm that the CGC, a price compensation fund meant to offset part of the cost of staple food and feed imports, may spend over $430 million in the current calendar year, up nearly 70%. CGC outlays are forecast to reach nearly $620 million, an amount equivalent to over 2% of the country’s GDP. Senegal has waived tariffs and value added taxes, imposed price controls and given subsidies to calm consumer anxiety. In drought-plagued Australia, the veto on over bulk wheat exports has been extended until June 2008.
In UK, food inflation increased in September, rising to 2.7% compared with 2.1% in August, the largest month-on-month increase since December 2006. The cost of a full English breakfast is soaring as animal feed is pushing up the cost of eggs, bacon and dairy produce. Wheat has also hit a record high, so toast isn’t the budget option either.
There could be egg shortages in the lead up to Christmas, for the first time since the Second World War. In China, authorities are concerned surging food prices have lifted inflation to levels not seen in a decade and may spill over into wages. And we all know what’s been happening in India on the food trade policy front.
For more than 40 years, international trade negotiations have been dominated by large exporters — the United States , EU, Canada , Argentina , and Australia — wanting greater market access in importing countries. Now the world may be moving into an age dominated not by surpluses but by shortages. So the issue is not exporters’ access to markets but importers’ access to supplies.
Whether it is Ramadan or elections or inflation, food prices are spooking every government. The good news is that trade barriers are rapidly dissolving as more nations buy overseas. The bad news is that governments can no longer be certain the shops would remain open. 2007 has shown that in an integrated world food market, everyone is affected by the same price shifts. That’s no small thing. This market has the power to hurt more people and destabilise more governments than any thing we have seen before.
What is it about the south that has become a STATE OF MIND for the upwardly mobile? The south of any city, South Mumbai for instance, has become a brand that can give top luxury marquees stiff competition. You can sport Gucci shoes, wear Chanel shades and even write your name with a Cartier, but nothing overshadows the flaunt value of your address. And all this is perhaps for a very special reason.
Suave residential areas in the south of many cities reflect a style that is rare and distinct. Be it the open, green spaces in South Delhi’s posh Shanti Niketan area or the sea-facing balconies of Nariman Point and Churchgate in South Mumbai, there is something about these locations that make people swoon.
Perhaps that is also the reason why prices have gone north in most of these south lying areas even though in other locations, prices have stabilised after interest rates peaked. So what Upper East Side is to Manhattan or the western Kensington district is to London — is what ‘south’ is to Delhi, Mumbai and even Chennai and Kolkata. In short, in India ‘south’ is where the rich and famous or anyone aspiring to be so would like to be. The south of any metro — South Mumbai for instance — has become a brand that can give top luxury marquees stiff competition.
So SundayET decided to go deeper south and probe why prices in these areas keep going north in Delhi, Mumbai, Kolkata, Chennai, Bangalore and Hyderabad. Starting with the Capital, premium and posh is definitely what the southern hub is all about. Consider this: An apartment in Vasant Vihar built on a 400 sq yds plot was recently sold for a whopping Rs 5 crore! Likewise, a villa measuring 215 sq yds in Asiad Village was sold for as much as Rs 3 crore!
Easy road access, proximity to Central Business District (CBD) locations and nearness to the best educational, health and recreational facilities have helped in making these areas prime in the Capital. Moreover, the growth of other office locations in South Delhi such as Bhikaji Cama Place and Nehru Place are other reasons which have further placed these residential boulevards on the wishlist for many top corporates and entrepreneurs.
While locations such as Shanti Niketan, Westend easily command approximately Rs 30,000/sq ft followed closely by Vasant Vihar and Anand Niketan at Rs 26,000/sq ft, average capital values in Greater Kailash I&II, South Extension, Hauz Khas and New Friends Colony start at Rs 14,000/sq ft, according to figures exclusively tracked for SundayET, by global real estate consultancy Cushman & Wakefield (C&W).
In Mumbai too, south and south-central locations such as Nariman Point, Churchgate, Colaba, Altamount Road, Malabar Hill, Napean Sea Road and Breach Candy are some of the most sought after residential addresses.
C&W pegs the average capital values in areas such as Colaba, Cuffe Parade and Nariman Point at Rs 24,000/sq ft; it is close to Rs 29,000/ sq ft in Malabar Hill, Napean Sea Road, Breach Candy and Peddar Road. The capital and rental values have increased here by almost 20-26% over the last 12 months. Other than the high prestige value attached to them, areas in South and South Central Mumbai have also been historically preferred as residential locations due to their proximity to the CBD. Not to forget the long sea-face that is an added incentive for the city’s elite to set up residences!
In trying to explain the reason behind this southern comfort, Aditi Vijayakar national head, transaction services – residential, India, C&W says: “Prime destinations like these continue to be expensive and in demand because, typically their occupants have ties with their homes and neighbourhood which may include friends, family, clubs, neighbours etc. Land is also not easily available in these localities for redevelopment — if it is, it comes at a premium, thus ensuring that a new apartment or home constructed here will be offered at a high value which again restricts sale to a high-end market.”
Agrees Rohtas Goel, CMD of real estate company Omaxe: “Prices for residential apartments have been going up in South Delhi and South Mumbai. This is only natural due to the high holding capacity of individuals in such locations, so a high interest rate does not really impact them in an adverse manner.”
Of course, Delhi’s ‘south’ phenomenon is a somewhat a recent development as Surinder Jodhka, professor of Sociology at JawaharLal Nehru University (JNU), points out. “In the case of Delhi, south came much later. It’s a place where the new elite settled in post independence. Such a phenomenon that sees South as premium locations in metro cities is only incidental, based on the way settlement patterns emerged after independence,” she says.
And the snob value around the southern districts is not just confined to Delhi and Mumbai. Good connectivity, mass transit facilities and nearness to the CBD have made Alipore and Ballygunj prime residential areas in South Kolkata. These areas have been the preferred residential locations for industrialists and top executives over generations.
Select residential projects seen in these areas have not added significantly to the supply. With no land parcel for further development and very little vacancy, the demand outstrips the supply in these locations. According to C&W, the average capital values here range between Rs 6,000/sq ft to Rs 7,000/sq ft and have witnessed an average increase in capital values of 20-28% in the last one year.
Boat Club in the south of Chennai too, is an elite address and offers a unique amalgam of traditional and modern architecture. Traditionally, with only a plotted development with independent bungalows, most of the apartments in this area are well constructed with a keen sense of material and design. The capital values have gone up here by approximately 50% in the last 12 months, according to C&W figures. The average capital values stand at Rs 13,500/sq ft for an apartment area of 2000 sq ft.
Southern suburbs in the Garden City of Bangalore include areas such as Koramangala, BTM Layout, Bannerghatta Road, Hosur Road, Jaynagar, JP Nagar and Wilson Gardens. Certain areas within Koramangala, Jayangar T Block and couple of phases in JP Nagar are considered among the prime residential areas in the city.
Land and bungalows in these areas are highly sought after by the high income group (HIG) as they are considered an asset to acquire or hold on to. That also explains why an independent bungalow measuring 4,850 sq ft located on a land area of approximately 10,000 sq ft was sold for close to Rs 110,000,000 in Koramanagala!
Hyderabad is no different. In Hyderabad, the area around Barketpura in the south is expected to see some rapid movement with the proposed new Airport at Shamshabad (extreme south of Hyderabad) expected to be complete in the next 12-15 months. The land rates in this area have seen an increase of about 10- 15% over the past 12 months, says C&W.
Commenting on the aspirational aspect of addresses in the southern parts of Indian cities, Kunal Banerji, president, marketing, Ansal API, says: “One can rub shoulders with the rich and mighty, hobnob with the fashion conscious, converse with the polished elite and also bring in some old style. In that sense, it is extremely aspirational for some to own a house in the south locations of metros.” So think again before you say prices are going south. What you probably mean is that they’re zooming up, at least in the south that is!
The initial public offer (IPO) of Dhanus Technologies has taken a knock following reports of CBI raids on the company. At the time of going to press, more than half of the qualified institutional buyers (QIBs) had withdrawn their money from the issue. They had over-subscribed the issue by 36.1730 times initially. The issue now stands oversubscribed by 16 times overall. Initially, the company’s IPO was oversubscribed 28.7 times.
“On the retail investors’ side, there has been a withdrawal by 2.43 times at last count. In terms of HNIs, there was a withdrawal of 1.85 times,” said Ashok Parekh, head of capital markets, SREI, a book running lead manager to the issue. Dhanus Technologies’ allotment for the retail investors category of the IPO was subscribed by 18.66 times.
S Muthukrishnan, director (marketing), Dhanus Technologies, however, said they were quite confident that the investors would stay invested.
The Chennai-based company was to raise Rs 110 crore from the market by offering 42 lakh equity shares of Rs 10 each at a price band of Rs 280 to Rs 295. The issue closed on September 12 and was fairly well subscribed.
Prithvi Haldea of Prime Database said the incident was not new. There have been cases in the past when companies, before the listing of the stock on the bourses, have given option to investors to withdraw. “However allegations such as this can lead to retail investors backing out. Now it is up to the investors to take a call if they have enough confidence in the issue,” he said.
Wednesday’s session was reminiscent of the frenzied days in the first quarter of 1992, when the entire financial community was engulfed by a feeling of euphoria. On this occasion, though the voice of reason prevailed towards the weekend, indicators suggest that the stampede of the bull may not be arrested just yet.
Turnover zoomed to record levels on Wednesday; as traders rushing in to join the bull band-wagon were ruthlessly stopped. FII cash inflows of over $700 million on that day imply that the recovery was largely fuelled by external investors. They have pumped in $2 billion in the last four trading sessions alone! However, derivative data indicates that foreign investors are taking adequate precautions by hedging their cash market positions through futures and options.
The Sensex moved past the near-term resistance at 17500 on Wednesday; and stopped a whisker short of the next milestone at 18000. The strength and ferocity of the Sensex move indicates that this is the third wave from the June 2006 trough of 8800. The third minor of the third is generally the swiftest, most profitable and leaves everyone gasping for breath. That probably describes the current situation perfectly. This wave has a plausible target at 20425. A strong third wave that unfurls to its utmost potential can take the benchmark beyond the afore-mentioned target.
The near term outlook for the Sensex stays positive though sharp intra-day swings can not be ruled out. The index can rise to 18096, 18468 or 18882 next week. A halt in the zone between 18400 and 18800 can usher in a medium term correction that can make the index fall to 17225 or 17000. The medium term outlook will turn negative only on a fall below 17000. Traders can buy in corrections as long the Sensex stays above 17200.
The main grudge that many are bearing at this juncture has to do with the swiftness of the rally. A sedate climb to 20000 by the end of 2008 would have been welcomed by all but a dash to the same level before the end of this year would cause considerable consternation. The way to tackle this phase would be to book profits on stocks that are overstretched and to reduce the exposure to the stock market as the index sears ahead. Having done that, investors should be prepared to stay on the sidelines for a few months to await the next buying opportunity at considerably lower levels.Nifty (5185.8)
The wave counts are always easy when the market is in an impulse move. We just need to set targets higher and higher, and the market would be there in no time at all.
Nifty moved past our outermost short-term target at 5176 to record an intra week top at 5261. Our medium term target stays at 5364 as indicated last week.
The upper targets for the week ahead are at 5230, 5295 and then 5364. A five-wave move could complete around 5350 in the Nifty and we could see a medium term correction thereafter. The magnitude of the correction would indicate the ability of the index to move higher towards 5564. The supports for the week ahead would be at 5007 and then 4946. Traders can continue to buy in corrections as long as the index trades above 5000.Global Cues
The Dow Jones moved past 14000 to a new high at 14124, as anticipated in our last column. Another weekly close past 14000 would mean that the structural bull market has resumed after the deep cut in August. Since this move would be the next leg of the up-move from the October 2005 trough, the DJIA could be heading for 14500 in the medium term. Though all the Asian indices put up a strong show last week, it is the Hang Seng that was the show-stopper; for once eclipsing the Shanghai Composite index. Hang Seng has already gained 43 per cent since its August 17 trough!Comex gold eased after recording a high of $747. This correction can make the commodity fall to $705, after which it can continue its up-move. Nymex crude is consolidating between $78 and $84. An upward break-out is imminent in the near term that can take the commodity past $90.
Post the Federal Reserve decision to cut the Fed Funds rate by 50 basis points to support liquidity and bolster the economy mid week we saw markets rally. This rally was accentuated in emerging markets as the risk trade was again reignited. However, this is a broader statement which needs further examination. Currencies are likely to play a role in global allocation of funds as investors reallocate those depreciating towards appreciating currencies. In fact if you look at flows of funds last week, we saw only a trickle in international funds flow, in comparison to emerging market funds. We expect further rates cuts over the next 6 months to address the situation in the US and UK. This will place a continued upward bias on emerging market allocation.
All above returns are upto 21st of September 2007. In this environment investors are likely to re-assess exposure to the US, UK and other markets which may be impacted by the sub-prime issues and depreciating currencies. In essence these may be seen as more risky markets than emerging markets. Markets like China and India will be primary benefactors as growth is visible and more reliant on domestic factors. This indeed would be a sea change to investor mentality and we feel it is likely to happen sooner rather than later.
We remain bullish on the prospects for India being a more attractive investment destination for investor funds. In the last report we stated a view of 5,500 to 6,000 by the first quarter of 2008 based on this bullishness. In this environment we expect Large Cap stocks to dominate the move upwards as
FII’s will focus on more liquid counters which are $1 billion or higher in market capitalization. Accordingly the small and mid capitalisation stocks are likely to show a lagged impact, however the political risk stands in the way of a unified local market appreciation.
In fact local mutual funds are likely to be sceptical due to their views on political risk and the impact it can have on the market. Local valuations are also likely to blown out of proportion for the time being as liquidity takes hold. We do not expect this situation to be ongoing, but may last till year end in a similar pattern to October, November 2006.
In addition sectoral positioning and stock picking abilities will be the major differentiator in performance. There are isolated ideas on rupee appreciation (underweight IT and Pharma) and a falling interest rate outlook (overweight Banks and Housing related). These positions are likely to be accentuated in the current market with players likely to follow a momentum based strategy.
Shareholders can continue to hold Sona Koyo Steering Systems with a two-three year perspective. The company, a supplier to the passenger cars market, is among the few component makers that have weathered the current slowdown in the industry relatively well. However, given the company’s focus on OEM supplies, order flow tends to be lumpy; revenue growth is expected to be of the order of 10 per cent in 2007-08. The company’s market leadership position and superior product mix, coupled with its plans to localise the column type EPS (C-EPS) components, imply that earnings can gain traction over three-five years; near-term prospects are muted though. Shareholders can hold on to the stock which now trades at a PE of 14 times the trailing twelve months earnings.Product, Revenue Mix
Sona Koyo’s product portfolio includes steering systems and driveline products. The former accounts for 85 per cent of the revenues and the latter the rest. Maruti Suzuki is the major client, contributing to 60 per cent of the total revenues; Hyundai and Mahindra (including Mahindra-Renault) chip in with 15 per cent each. Toyota Kirloskar and Tata Motors make up the rest. In 2006-07, the company saw a whopping 72 per cent rise in sales due to the introduction of Electronic Power Steering (EPS) systems. This is an exceptional increase, triggered by supplies to a set of small car OEMs (Original Equipment Manufacturers) led by Maruti.
A tilt in the product mix towards power steering impacted margins in 2006-07 (10.3 per cent against 11.1 per cent in 2005-06) as the product features a high import content. However, the same factor worked in favour of the company in the first quarter of 2007-08, as operating margins improved on the back of an appreciating rupee.Prospects
The sustained growth in domestic passenger car sales augurs well for the company. The company is favourably placed to tap this growing market.
One, Sona Koyo already has a strong presence in the compact car segment supplying to models such as Alto, Wagon R, Estilo and Santro. Given the plans to make India a global hub for compact cars, the company’s client base will expand.
Second, the emergence of a low-cost, entry-level car, developed for the mass market, could open up a new market segment for Sona Koyo.
To benefit from such volume-driven requirements, the company is setting up a manufacturing facility in West Bengal to cater to Tata Motors’ Rs 1-lakh car project.
Third, the company being the pioneer in EPS in India, will have the first mover advantage when the demand for such components increases over the next few years. In 2006-07, Sona Koyo added capacity for manufacturing 3,00,000 units of C-EPS at Gurgaon. The company has also set up a plant at Dharuhera, Pune for the same.Exports
Exports contribute around 7 per cent of the revenues. However, the company has revised downward its 2010 export target from 45 per cent of revenues to 35 per cent due to the greater potential that the domestic market offers.
To achieve the export target, Sona Koyo is strengthening its design and development capabilities through in-house/acquired technology/R&D.
The company is currently developing EPS for off-highway vehicles in the US markets where the demand is expected to be strong.
It is also looking at leveraging its association with the joint-venture partner, Fuji Kiko, through which Sona Koyo has gained a toehold in the European and Latin American markets.
However, for Sona Koyo, the domestic market may offer a more lucrative source of growth, given the growth potential for compact cars in this market.
Investors with a high risk appetite can consider exposure, with a two-three year perspective, in the stock of Action Construction Equipment (ACE). ACE has an expanding product portfolio, uses competitive pricing and well-established distribution network, which could help it capitalise on the ongoing infrastructure boom, over the next two-three years.
ACE’s capacity expansion and presence in Europe, through its recent acquisition of a Romanian company, also bolster its growth prospects. At the current market price of Rs 335, the stock trades at about 18 times its likely FY09 per share earnings. This valuation is not inexpensive; but the historical earnings growth managed by ACE and its business plans suggest that it is well-placed to take advantage of the boom phase in the construction segment. .Investment argument
The demand environment for construction equipment companies appears bright, given the government’s increasing focus on infrastructure and construction. While this augurs well for all companies in this space, it has also intensified competition. In the hydraulic cranes segment, which contributes about 90 per cent of total revenues, ACE is likely to continue enjoying a higher visibility in the market for two reasons– one, its market share of about 50 per cent and two, its pricing strategy. ACE prices its cranes at a significant discount to other playersTo reduce its dependence on the cranes segment, ACE has forayed into the forklift and backhoe loaders segment. The company expects to break through the backhoe loaders market, which is mainly dominated by JCB , on the basis of its aggressive pricing strategy.
, It could well succeed in garnering business given the robust demand scenario. The company has capacity to manufacture 50 backhoe loaders per month.
In the forklift segment, however, the company has planned its entry strategy differently. It plans to import the forklift trucks in CKD (completely-knocked down) condition from a Chinese company. In this segment again, while competition from Godrej and Voltas, which have about 90-95 per cent market share, cannot be ignored, the management expects the pricing strategy and distribution network to help it gain market share. Interestingly, in the forklifts segment, ACE has positioned its products, claimed to be superior in technology, at price points that are comparable to products offered by the existing players.
While such an aggressive pricing strategy means lower margins, it is also likely to build volumes, thus helping ACE sell its new products.Inorganic growth
ACE’s acquisition of 74 per cent stake of a Romanian company is likely to give it access to the European market. ACE plans to ship its products in semi-knocked down condition to its Romanian facility and import engines and other spare parts from other countries. This could contribute significantly to its bottomline, given that margins are likely to be on the high side.
For the quarter ended June 2007, ACE reported a 91 per cent growth in earnings backed by 67 per cent increase in revenues. Operating margins, owing to higher steel price, dipped to about 10.7 per cent. ACE’s discount pricing strategy means that margins may not witness significant expansion but margin pressure will likely ease with the change in revenue mix from FY 09.Concerns
Any unprecedented hike in steel prices could exert pressure on ACE’s margins, especially given that its strategy relies heavily on competitive pricing.
The possibility of other large players in the market also following suit on pricing exists and this could impact ACE’s competitive advantage. This apart, the stock’s valuation isfairly high and any slowdown in earnings performance could cause a slide in the price.
Investors can consider buying shares of Gujarat State Petronet (GSPL) at the current price of Rs 61 with a two-three-year holding perspective.
The company, with its growing network of pipelines criss-crossing Gujarat, is well-positioned to ride on the higher gas volumes that will hit the State in a year’s time.
The agreement with Reliance Industries to transport its KG Basin gas and the expansion of the pipeline network to high gas market potential areas such as Morbi should ensure sustained growth in transportation volumes. GSPL’s parentage (it is a subsidiary of Gujarat State Petroleum Corporation) and its entrenched position in the mature Gujarat market are added comfort factors.Business profile
GSPL is a gas transmission company that offers its pipeline network, now confined to Gujarat, on open-access basis to transport gas for customers.
Gas producers, traders and LNG terminal operators along with consumers such as power and fertiliser companies, chemical plants and city-gas distribution companies constitute the customers for GSPL. GSPL does not market the gas and revenue comes from transportation charges only.
The company owns 1,130 km of pipelines in Gujarat connecting supply centres such as Hazira and Dahej to markets in Vapi, Morbi, Kalol, Vadodara and Rajkot. A further 400 km of pipelines are under construction now.
Last fiscal, the company transported close to 18 million standard cubic metres per day (MMSCMD) of gas..Growth drivers
GSPL will be transporting upto 15 MMSCMD of KG Basin gas for Reliance Industries from a delivery point in Gujarat to the latter’s refinery in Jamnagar. Though the initial gas transmission agreement is only for 11 MMSCMD for a 15-year period, it is expected that transmission volumes will increase steadily as output from the KG Basin increases.
GSPL will be laying a new pipeline from Bhadabut, the delivery point designated by Reliance, to Jamnagar for this purpose.
The expansion of the network to Morbi is likely to increase volumes as ceramic tile producers there convert to cheaper natural gas. GSPL is also likely to benefit from the fast growing city gas distribution (CGD) business in cities such as Ahmedabad, Surat and Vapi. The company is picking up strategic equity stakes in GSPC Gas Company Ltd. and Sabarmati Gas Ltd., which are developing CGD businesses in Gujarat. GSPL is also a 11 per cent equity holder in Krishna Godavari Gas Network Ltd., which plans to develop a CGD network in Andhra Pradesh.
On the supply side, the output from the ageing Hazira fields owned by parent GSPC is declining but higher throughput from Shell’s LNG facility and of Petronet LNG in Dahej is likely to more than compensate. Volumes from the Panna-Mukta-Tapti joint venture are also likely to marginally increase, but the big push would come when Reliance’s KG Basin gas hits the Gujarat market late in 2008 followed by that of GSPC in a couple of years.
GSPL sits pretty in a market that is set to witness rapid growth in gas supply and demand in the next couple of years.Interest overhang
Thanks to the frenetic pace of expansion and the consequent large borrowings, GSPL’s interest costs are shooting upwards.
It more than doubled to Rs 19.80 crore in the first quarter of this year compared to the same period last year and the trend line is pointed upwards. Similarly, depreciation charge has also been increasing as the company commissions newer pipeline capacities. Together, interest and depreciation are likely to cast a shadow on near-term earnings growth.
In the first quarter, despite a 48 per cent growth in operating profit to Rs 88.73 crore, post-tax earnings fell 7.5 per cent to Rs 17.87 crore mainly due to higher interest and depreciation charge.
However, as transportation volumes increase over the next few quarters, the impact will be muted to some extent.
The price-earnings multiple is a stiff 46 based on annualised first quarter 2007-08 earnings but given that the company is still in the investment mode, PEM comparisons could be misleading.
Earnings are bound to quickly catch up with valuations once the pipelines are commissioned and gas transportation volume increases. The GSPL stock is for investors willing to stay invested in the medium-term.
Investors with a 2-3 year perspective can consider buying the stock of Prajay Engineers Syndicate. Land holdings acquired at low cost and projects in hand that could translate into higher revenues, superior return on equity and attractive valuations make this stock a preferred investment among the middle-rung real estate companies. At the current market price, the stock trades at eight times its expected earnings for FY 2008, assuming full conversion of its foreign currency convertible bonds into equity.
Prajay has made steady progress in its business, starting out as a low-cost housing developer and transforming into a builder of premium houses. It has traditionally enjoyed high operating profit margins (OPMs) on the back of high demand and a low cost land bank mostly in Hyderabad. After foraying into premium segments, the company now benefits from healthy volumes as well as high returns from its projects. This is reflected in the company’s OPMs jumping from about 31 per cent in 2004-05 to 47 per cent in 2006-07.
The residential segment, especially in Hyderabad, has traditionally accounted for most of the company’s revenues. Prajay has, however, diversified to foray into the commercial, retail and hospitality segments, which now account for about 28 per cent of its current developable area. Most of these projects are in Hyderabad, indicating that the company prefers to contain risk by treading on familiar ground. For its venture into the hospitality segment, Prajay has chosen its locations well. For instance, its five-star hotel near the Shamshabad International airport can be expected to have robust occupancy, given the air traffic growth in Hyderabad and that the old airport would no longer function after the new one becomes operational by mid-2008.
Prajay has a comfortable land bank of 850 acres, mostly in Andhra Pradesh and hopes to develop 32 million square feet of saleable area over the next five years. This does appear challenging, as it is nearly four times the size of projects executed so far. However, the company’s familiarity with the region, its joint venture with the Malaysia-based realty player Sunway Group and comfortable financials after raising funds through FCCBs in 2006, allay concerns about execution risks. The stock may not be able to enjoy the premium valuations enjoyed by the more geographically diversified real estate players. The good growth prospects and consistency in financial performance, aided by an improving home loan interest rate scenario, suggest that the stock could have good potential.
Investment with a one-two year horizon can be considered in the Tata Consultancy Services (TCS) stock considering its strong business fundamentals and availability at valuations that appear to capture its growth prospects.
IT stocks have taken a beating over the last few months on the back of the appreciating rupee and fears of the US sub-prime crisis affecting their Banking Financial Services Insurance (BFSI) clientele. This has resulted in the top-tier IT stocks being available at a discount to their historical valuations.
TCS has hedged about $2.5 billion — nearly 55 per cent of its revenues — at about Rs 41 to the dollar, partially mitigating the effect of the appreciating rupee. Also, compared to the 7 per cent appreciation in the April-June quarter, the rupee has traded in a narrow band of Rs 39.5-40.5 for most part of the second quarter. This may reduce the impact of currency fluctuation on the sequential numbers.
In any case, geographic de-risking is already working for the company, with increased presence in Europe, South America and the Asia-Pacific. TCS’ direct exposure to mortgage clients is less than one per cent of its revenues and may not pose a serious threat to its business.
At the current market price (Rs 1070), the stock trades at about 25 times its trailing twelve-month earnings.
This is at a discount to Infosys, which is significant, because TCS may deliver the growth levels that this valuation demands and has weathered the rupee appreciation better. Wage hikes of 12-15 per cent were effected last quarter and should not be a burden on margins for the remaining three quarters of this year.Business prospects
New SBU gives greater focus: TCS has recently carved out a Strategic Business Unit (SBU) for its financial products (TCS BaNCS) division, with a separate management team. This has helped TCS focus on deals with large financial institutions, stock exchanges and insurance companies.
TCS BaNCS has functional modules to cater to a wide variety of BFSI clientele. The product conforms to international settlement and banking standards, thus making way for seamless integration with minimal customisation. To cite a few examples, HDFC Bank has implemented the product for its treasury operations; New Zealand stock exchange has taken the market infrastructure module; General Insurance Corporation has implemented its insurance module.
Where application development or maintenance or routine IT services are required, the regular BFSI vertical would come to the fore. The modularity of the product may appeal to large clients, given the potential for quick implementation. This demarcation enables greater focus and targeted client mining, evident from the fact that the State Bank of India and Bank of China are now on the list of clients which would be implementing the product. The products business offers high margins and, hence, increased profitability.
Offshored consulting: Consulting, which is a high-value service, tends to be high-cost revenue for IT vendors, as most consulting work is carried out onsite. TCS, leveraging on its ‘global network delivery model’, is now deriving one-fourth of its consulting revenues from services delivered offshore, which creates a low-cost structure. This strategy, if expanded in scale, would significantly increase margins for the company. The company has indicated that it is looking to move in that direction.
Synergy with CMC: In chasing deals that are systems integration intensive, TCS has a synergistic advantage from the expertise of its subsidiary, CMC. This is especially significant in infrastructure management services, a fast-growing-high-revenue service where CMC has vast experience in implementing IT products across a wide range of international vendors.
The other advantage that CMC brings is strong domestic presence and a sizeable government clientele. TCS may be well-placed to tap this segment as various government utilities increase their IT spends.
High fixed price billing: TCS derives over 40 per cent of its revenues from fixed price billing, the highest among top-tier Indian IT players. Of the two key methods of billing, fixed price contracts are done on the basis of proportion of work completed, while time and material billing is based on resources deployed in the project, often on a per hour basis. The ability to price a contract on fixed billing requires a clear ability to forecast the timelines, resources and expertise required to complete a project. This can help predict cash flows and formulate a suitable hedging strategy. Increasingly, international clients are demanding such a pattern from Indian vendors.Cost optimisation levers
Recruitment strategy: With growing difficulty in finding talented manpower (read engineers), TCS has begun to recruit science graduates, a strategy which other IT companies too are implementing, though on a smaller scale.
With a program called ‘Ignite’, these graduates will be imparted a seven-month training to put them live on projects. As many as 500 graduates have been recruited and TCS plans to increase this to 2,000 within this financial year. This move could address the double-whammy of attrition and wage inflation for the company.
Geographic de-risking: Non-North-American clientele (Europe, MEA, and Asia Pacific) contribute nearly 48 per cent of the company’s revenues. This may help TCS diversify its currency exposures and, thereby, reduce the exposure to the dollar.
Healthy repeat business: TCS has a repeat business percentage of over 96 per cent, which is further evidence of improving quality of service delivery.
A high repeat business percentage may also help reduce sales expenditure to mine new clients. This is in addition to the fact that for five of its six $100 million-plus clients, it is offering the almost the entire gamut of IT and BPO services. This ensures optimal deployment of resources and a more sustainable revenue stream.Risks
As TCS goes in pursuit of large size deals, it may have to face international competition from players such as IBM and Accenture who are integrated to a greater degree. This may also impose a strain on margins. Vendor rationalisation by large clients in the US and elsewhere may mean a reduced pie for TCS. Utilisation levels are close to 80 per cent; increasing this for greater volume-driven growth may pose a challenge.
The bulls extended their winning streak to the seventh week and the Sensex has now gained a massive 25.7% (3,632 points) during the period.
The Sensex began last week on a cautious note and dropped to a low of 17,145. However, unabated buying thereafter saw the index come within striking distance of 18,000, another milestone. The index hit a fresh all-time intra-day high of 17,979, just 21 points short of the 18,000-mark.
The intra-week swing for the index was a good 835 points. The Sensex finally ended the week with a gain of 2.8% (482 points) at 17,773.
This could be a key week for the markets, as the earnings season kicks off. The markets may rally further or consolidate at current levels in case the results meet expectations. However, in the event of any disappointment, the markets may take a sharp dip.
The Sensex is moving in unchartered territory with the key support at 17,000 levels, a break of which could see the index dropping to 15,800. On the upside, the index has a potential to rally up to 19,000.
The index may face resistance at around 18,090-18,190-18,290 this week, while it is likely to find support around 17,455-17,355-17,255 in case of a downside.
After moving in a range of 260-odd points, the Nifty touched a fresh peak at 5261 and finally ended with gains of 164 points at 5186. It has now gained a whopping 26.2% (1,078 points) in seven weeks.
The Nifty may face resistance around 5285-5315-5345 this week, while there would be downside support at around 5085-5055-5025.
The Nifty has strong support at 5020. If the index breaks this level, it may slide to 4780.
The outlook for the markets will remain bullish in the short-term as long as the Sensex and the Nifty hold their key support levels of 17,000 and 5020 respectively.