Sunday, July 20, 2008
For every rupee of earnings managed by BSE Sensex companies, investors are today willing to pay only half of what they paid in January 2008.
The market meltdown of 2008 has seen the Sensex value fall by 35 per cent till date, but it has halved the price-to-earnings multiple (PE multiple) for companies in the bellwether index.
The PE multiple of the Sensex, which was at a rich 28 times (based on historic 12-month earnings) at 21,000 levels, has plunged to a staid 14 times now, Bloomberg data shows. The lower valuation indicates that investors now expect Sensex companies to grow at only half the rate that they factored in, in January.
World over, investors value companies based on potential growth and the PE multiple is one of the widely used tools to evaluate how expensive or cheap stocks are, relative to their growth prospects.
Worst in a decade
The erosion in Sensex PE multiple in this meltdown may be the worst in a decade, even including the dotcom crash of 2001.
Banking and realty companies have been worst hit, with SBI seeing its PE multiple fall from 20 times to just 6, while DLF has seen its PE plunge from 90 times to 8 times.
Reliance Industries, Jaiprakash Associates, SBI, Tata Steel, Reliance Infrastructure (formerly Reliance Energy) and DLF, are among companies that have seen their PE multiples trimmed to half their January level.
Many of these companies have seen their valuation fall even as they managed a sharp ramp-up in their earnings for 2007-08.
DLF (earnings per share grew from Rs 13 to Rs 47 between FY07 and FY08), Bharti Airtel (Rs 21 to Rs 34), HDFC (Rs 69 to Rs 100) are key instances.
While concerns about rising interest rates have prompted investors to tone down growth expectations from bank and realty companies, worries about the economy slowing down have made them ‘de-rate’ infrastructure and capital goods stocks.
Companies in the Sensex basket that have managed to escape this bout of de-rating are Infosys, Satyam, Ranbaxy Labs, Cipla and Hindalco, which have more or less held on to their PE multiples.
The markets bounced back sharply in the last two days of the trading week, mainly on account of short-covering in banking stocks, as the US markets rebounded. Realty and energy stocks logged smart gains.
The Nifty hit a fresh calendar low of 3,790 (close to the support level of 3,770 mentioned last week) and then pulled back to higher levels. The buying momentum was so strong that the index zipped past the 4,000-mark to a high of 4,118. The index finally settled with gains of 43 points at 4,092.
The Nifty MACD (moving average convergence divergence) and Stochastic Slow indicate more upside. The index could re-test its recent high of 4,215. If it sustains above this level, one may see the 4,500 level in the medium term.
The index closed above its short-term moving (20-days) average (4,064) after a gap of 41 days. The medium-term (50-days) moving average is 4,492. Going forward, the 3,850 level will be crucial. The Nifty may see a further upside as long as it trades above this level. But a dip below the mark could take the index up to 3,400-3,250.
The Nifty is likely to find support around 3,965-3,930-3,890, while it may face resistance around 4,215-4,255-4,295 this week.
The Sensex moved in a range of 1,170 points - from a low of 12,514, the index rallied to a high of 13,684 and finally ended with gains of 165 points at 13,635.
Among the index stocks, ONGC and Maruti soared 11 per cent each. Larsen & Toubro, Bharti Airtel, NTPC, Reliance Infrastructure and SBI gained 6-8 per cent each. On the other hand, Ranbaxy slumped 18 per cent to Rs 531, and Satyam, Wipro, Tata Steel, Hindalco and Infosys dropped 8-14 per cent each.
The domestic sugar cycle is set to enter a favourable phase for producers, with output expected to decline sharply over the next two years, lending support to sugar prices.
Investors looking to capitalise on this trend can consider buying the stock of Shree Renuka Sugars, a South-based integrated sugar producer.
With sizeable capacities coming on-stream this year, Shree Renuka appears well-placed, among large listed players, to capitalise on a scenario of firming sugar prices amidst dwindling cane supplies.
At the current market price of Rs 113, the stock trades at about 11 times its estimated earnings for 2008-09 (year ending September).
Shree Renuka has used proceeds of earlier equity offers to fund an ambitious expansion in sugar (now at 25,250 tcd), distillery (450 klpd) and power cogeneration (103.5 MW) capacities.
It augments owned capacity with facilities leased from cooperative sugar mills; making for a less capital intensive model.
With the commissioning of a Haldia-based refinery in June, the company also has sugar refining capacities of 4000 tpd under its belt. Units located in Karnataka and Maharashtra allow the company to source cane at competitive prices, unlike Uttar Pradesh-based mills which have to shell out higher state-fixed prices.
After a two-year slump, domestic sugar prices are set to firm up over the next year, on the back of a 20 per cent drop in sugar output in the crushing season commencing October 1 and lower inventories.
Recent policy changes which allow sugar mills to process cane directly into ethanol also allow producers to switch between the two products, based on demand and relative realisations.
Going forward, while rising domestic prices would improve the profit margin on the company’s core sugar business, favourable policies on ethanol (for which the company is the leading supplier) and revenues from power, will also bring in sizeable revenues.
Both ethanol and power capacities will be substantially scaled up this year.
Port-based refining facilities, backed by a recent sourcing arrangement with a Brazilian sugar producer, may help the company tap export opportunities in neighbouring Asian and West Asian markets, amidst rising global sugar prices.
Looking ahead, any policy changes to decontrol sugar will be a positive trigger to the stock price.
The key risks to the earnings outlook may arise from any upward revision in output estimates and any policy moves that seek to restrict sugar exports, to quell prices.
Investors can avoid the initial public offering of Vishal Information Technologies, a company delivering digitisation and E-Publishing services, considering the high valuation that the offer demands and the inherent business risks, given the rough macro-environment.
At Rs 150 (upper end of price band), the offer is priced 14 times the company’s 2007-08 per share earnings on post-offer equity base.
This is at a premium to most BPO/KPO players in the mid and small tier space, which have more diversified service offerings than Vishal Information.
Heavy competition in all segments of its operations, a long receivables cycle, lack of diversification in its service portfolio and client concentration are key risks to the business.
Vishal Information delivers digitisation, e-publishing and digital library services to publishers.
The company has also been able to create digital library formatting for visually challenged people to access books by downloading text from the Internet.
In addition, Vishal has a subsidiary that handles back-end accounting and administrative services for financial services clients.
Vishal Information’s revenues over the last five years have grown at a compounded annual rate of 24.1 per cent to Rs 40.9 crore for 2007-08, while revenues have grown at a rate of 24 per cent to Rs 12.4 crore during the same period.
The absence of diversification from the core business makes the company vulnerable to vagaries of publishing houses’ outsourcing schedules. Competition exists for the company from three sets of players. Large companies that have a diversified KPO services basket in addition to publication services such as RR Donnelley (Office Tiger), Hexaware Technologies and TCS; independent KPO players such as Scientific Publishing and Ninestar Information Technologies that specialise in digitisation; and captive units of publication houses.
In this light, pressure may be on billing rates with clients, and with a rough macro environment, it may only get tougher to stay competitive and maintain margins.
Cushion from diversification in the form of voice and other transaction based services that BPOs/KPOs provide across several verticals is not available to Vishal Information. Technology upgrade may not be as easily possible for a smaller player such as Vishal when compared to well-entrenched players with deeper pockets.
Scalability has also been a problem, a fact supported by the sedate growth rates even during the outsourcing boom phase of 2003-07. Now, in a tough environment with companies cutting on outsourcing budget, the company may feel the pinch even more.
The company also has high concentration risks with its top three clients accounting for 56 per cent of revenues. In the absence of many long-term contracts or continuously large orders, the company may be subject to fluctuation in results.
Vishal receives its payments for projects only over a six-eight month period, after its clients successfully upload the completed publications on their Web sites.
This large timeline in receivables would significantly increase working capital requirements.
In a rising interest rate scenario, bank borrowings for such purposes would significantly increase expenses on this count.
Considering these aspects, investors may avoid this initial public offering