Sunday, August 24, 2008
Stock markets in the country will remain bullish in the long run but with intermittent downtrends as they are facing now, according to equity investor Rakesh Jhunjhunwala.
"I strongly believe that India's economic growth is based on structural factors and not on cyclical factors. I see no reason why the stock markets cannot remain bullish," Jhunjhunwala said at "Sensational Sensex-Retrospect and Prospect," as part of the Thought Leader Lecture Series, organised by CII, Hyderabad Chapter here.
Jhunjhunwala said his predictions were based on factors like strong economic growth, superb corporate performance, huge under-exposure to equities, growth in financial savings and tectonic shift of investments from the western world to emerging markets like India.
The only problem is to predict how frequently and for how long would markets experience bearish trends, he added.
Terming the Sensex as "sensational", for the kind of returns it has offered investors over the last 29 years, he said no other investments on any sector would have given about 18 per cent compound return on investments per annum for the last three decades as the Indian stock markets have.
He pointed out that India enjoys certain growth enablers such as its culture of tolerance, educational base, skilled individuals, economic factors like a well-developed entrepreneurial class, vast natural resources, strong resilience, strong democratic foundations, secular fabric, young population and finally its nuclear power.
All these would definiely catapult the sensex in the coming years, he added.
The Indian stock market is a function of the country’s economic growth, return on equity and return on capital employed, said Mr Rakesh Jhunjhunwala, Partner, RARE Enterprises and eminent equity investor.
Delivering a lecture organised by Confederation of Indian Industry titled ‘Sensational Sensex – Retrospect and Prospect’ he said: “Also, infrastructure to attract local money, growth of the Indian financial savings, correction of Indian under-exposure to equities are some of the other factors that will drive the markets,” he said.
He said the movement of the Sensex from 3,000 to 21,000 over a five-year period (2003-2007) and now back to 14,000 was no mean achievement.
“In this entire journey, we have had a few significant price-wise corrections but almost no time-wise correction. This is the first significant time-wise and price-wise correction being witnessed,” he said.
Analysing the genesis of the Indian downturn, Mr Jhunjhunwala said, until now we have had three bear markets. “In April 1992, the peak PE was at 63.1 per cent and we have the scam of Mr Harshad Mehta, then in 1994 we peaked at 42 times the earnings, then in December 1999 we peaked at 30 times the earning and had the Ketan Parekh scam. In 2008, we peaked at 21 times the earnings with no scams. While there was euphoria and mania, this time we have peaked at a far more reasonable valuation and are still below peak PE levels of the past,” he said.
Factors to watch
According to Mr Jhunjhunwala, the key factors to watch for are the US economy and world slowdown, global financial system stability, commodity prices, local and global inflation. “Also political elections, the performance of the Indian IT sector, base forming patterns in equity indices and Indian and foreign fund flows are other key factors to watch for the markets,” he said.
He noted that the aftermath of the 25-year-old US bull market cannot be pretty and the end of the easy money era in the financial markets will shake many out of complacency.
Kingfisher Airlines on Friday announced that it would launch international service from India with the debut of daily non-stop flights between Bangalore and London-Heathrow on September 3. Tickets are now on sale for the new route. The flight from Bangalore will depart at 8.40 am and arrive at London Heathrow's Terminal 4 at 2.50 pm, local time. The return flight will depart Heathrow at 10.05 pm and arrive in Bangalore the next day at 12.35 pm, local time. The flights will be operated using a brand new Airbus A330-200. The airline has also secured permission to fly to 13 overseas destinations, according to a business daily. Kingfisher plans to launch flights to the US, UK, UAE, Singapore, Thailand, Maldives, Saudi Arabia, Kuwait, Bangladesh, Malaysia, Sri Lanka, Pakistan and Hong Kong, it added.
Investors with a long-term perspective can consider exposure to the Motherson Sumi stock. At the current market price of Rs 80, the stock trades at a price-earnings multiple of about 15 (estimated FY-10 earnings). Though this valuation may seem expensive when compared to other auto component players, the company’s market leadership position in the wiring harness segment and focus on the supply of higher margin assemblies and modules justifies the premium valuation the company enjoys.
This, along with the foray into the non-auto segment provides visibility to the company’s earnings prospects in the next few years.
Higher volumes, better realisations expected
Motherson Sumi has around 65 per cent share in the domestic market in supplying wiring harness, high tension cords, wires and fuses to auto makers such as Maruti, Hyundai, Honda, Toyota, M&M and General Motors.
The steady demand for passenger cars, despite a slowdown in the two-wheelers and commercial vehicles segment, capacity expansion and the planned introduction of models by Maruti and Hyundai, augur well for the company as it would lead to strong volume growth in the next few years.
0Both carmakers have also made India the global manufacturing hub for small cars. Besides, with Nissan and Volkswagen foraying into the Indian market, the company is likely to supply to them as well, given the existing relationship of its collaborator, Sumitomo Wiring Systems (SWS), with these companies.
The company will also benefit from the trend of automakers introducing new safety and comfort features, as these features demand more complex wiring harnesses. This value-addition, in turn, may lead to better realisations for the company.
Apart from supplying domestically, the company has strong export sales, supplying wiring harness to motorcycle (30 per cent market share), tractor and off-road vehicle manufacturers in Europe. It also serves as a sourcing base for its collaborators.
Supplies to SWS are expected to further strengthen in the coming years as Motherson Sumi has already entered into a joint venture with SWS-Sharjah to service SWS’s European clients. The group is also hoping to locate about 85 per cent of its wiring harness production outside of Japan from 2008 and, India, as a preferred low-cost destination, may benefit from this.
Likely margin boost from polymers
In a bid to expand its product portfolio, the company also supplies injection and blow moulded components and assemblies and integrated modules such as door trims to auto makers. The increasing use of plastic content in cars so as to reduce costs and weight will translate into good business for this division. This bodes well for margin expansion as well, as supply of assemblies and modules bring in higher margins than components. The polymers division now accounts for about 25 per cent of the revenues.
More content per car
The company has a policy of increasing its content supplied per car by entering into joint ventures (JVs) with leading Tier-I suppliers. For the manufacture of rubber parts, the company is in a JV with WOCO of Germany. About 10 per cent of the revenues now come from the supply of rubber components.
Similarly, the company, last year entered into a JV with Calsonic Kansei, a global component manufacturer specialising in climate control systems and power-train cooling modules.
This JV will initially manufacture automotive AC units for Japanese car manufacturers in India. Production is slated to start in 2009.
Such a growth strategy will give the company access to latest technology, expand its clientele and bring more business from existing clients. This strategy is in sync with the company’s plans to emerge as a complete, full systems solutions provider.
To further shield itself from any slowdown in the auto sector, the company has entered into a joint venture with Balda AG of Germany to manufacture components for mobile handsets in India.
The company is also manufacturing Aerobin, a garbage disposal machine for the Australian market. This diversification primarily arises from the company’s core capacity to manufacture plastic components. But the contribution to revenues from these forays remains to be seen.
For the quarter-ended June 2008, net sales grew by 15 per cent to Rs 346 crore compared to the same period a year ago. While domestic sales grew by 10 per cent, exports rose by 32 per cent.
Being the market leader, the company has been able to pass on input cost increase to its customers, keeping the impact on profits minimal. But what has actually pulled down the net profits from about Rs 30 crore in the June 2007 quarter to Rs 12.7 crore in the current quarter is a forex loss of Rs 25 crore on account of restatement of liabilities.
Investments can be retained in the stock of Elecon Engineering, an established player in both material handling equipment (MHE) and industrial gears business. At the current market price of Rs 112, the stock trades at about 11 times its likely FY-10 per share earnings, down significantly from its peak of Rs 330 in January. While much of this fall can be explained by the broad-based selling in the market, the stock was also beaten down in anticipation of slowing demand and contraction in margins for the company, as there was a sharp run up in steel price during the period.
These concerns have, however, partly receded with the company’s good first quarter earnings performance. In the June quarter, not only did Elecon manage to strengthen its order-book; it also bettered its profit margins. This lends confidence to the company’s ability to grow despite challenging macro environment.
Further, Elecon’s entry into new businesses — windmills and windmill gear boxes — while currently insignificant in terms of revenue contribution, holds potential to deliver strong long-term growth, thus making it worthwhile to remain invested in the stock.
Fragmented user base
Unlike other infrastructure and capital goods companies, Elecon caters to a fragmented user industry base made up of power, steel, cement, sugar, mining and ports. This may explain why the company has so far not encountered any significant slowdown in the overall demand for its products. Apart from the power sector and, to some extent, cement, no other sector contributes significantly to the company’s overall revenue pie. That the company is now slowly increasing its focus on the steel sector (recently bagged Rs 400-crore worth orders from Bramhani Industries) may help it weather any slowdown in the cement sector, where the capex cycle may be nearing its peak.
For the quarter-ended June 2008, Elecon registered a 30 per cent growth in sales and 15 per cent increase in profits. On a segmental basis, while the MHE division grew by 58 per cent, the gears division witnessed a sedate growth of 8 per cent.
On the margins front, however, the company’s performance was commendable. Despite mounting pressure on input costs, Elecon improved its margins by 2 percentage points to about 17 per cent. Price escalation clauses for orders secured from NTPC and SEBs (State electricity boards) and higher margins for the remaining orders helped it improve margins. And given that steel, its primary raw material, is showing signs of cooling down, Elecon may well be able to sustain margins at the current levels in the coming quarters too.
Buoyant order book
The strong growth in Elecon’s order-book is testimony to the continuing demand for its products. At the end of the first quarter, Elecon had an unexecuted order-book of Rs 1,399 crore (1.7 times FY-08 sales), of which Rs 1,158 crore (83 per cent) came from its material handling division; on a year-on-year basis, this marks a growth of over 61 per cent in its order-book. However, there was a 37 per cent drop in orders booked during the quarter. This is in sharp contrast to the same quarter last year when the revenues booked had increased by a whopping 139 per cent. High base apart, the drop this time around can be partly attributed to delays in booking orders in the quarter.
While this can also be construed as slowdown in demand, that the company has, in the recent past, procured large orders and has suggested that it has quite a few orders in the pipeline, may provide some relief.
New business initiatives
Elecon’s entry into windmills and windmill gear boxes holds tremendous long-term growth potential, given the global supply constraints for gearboxes. While Elecon is yet to forge a technical tie-up for the same, it has indicated that the formal agreement should be in place by the end of this quarter.
The management has said that it has begun prototyping for windmill gear boxes of about 1 MW range for its customer. Further, it has already installed six wind turbine generators in Gujarat and supplied four in Maharashtra. The windmill gear box division is expected to be fully operational by next quarter.
The success of these new initiatives is extremely critical for Elecon as its revenue guidance for the next two years takes into account contribution from these businesses as well.
And since there have been delays in this regard — one of the reasons for the stock’s plunge — progress on execution and order booking in this segment may be key triggers to the stock price. Any further delay will pose a downside risk to the company’s revenues.
Any significant slowdown in the economy, leading to a sharp slowdown in capex across sectors, can hamper the growth prospects of Elecon. While the company has remained unscathed from the impact of a slowing economy, the lag effect of higher interest rates may soon catch up.
On this score, growth in the company’s order-book provides comfort on revenues over the next two years, by which time there may be more clarity on the economy front. Till such time, trends in order-booking in the coming quarters need to be watched closely.
Apple's iconic 3G iPhone made its debut in India, sans the public frenzy that greeted its worldwide debut last month, as a steep price and mixed reviews kept potential buyers at bay. Vodafone Essar, the Indian unit of the UK-based wireless major and Bharti Airtel, India's leading GSM operator, launched the latest version of Apple's smart phone in the country on August 22. The 8GB 3G iPhone is available in India at Rs31,000 while the 16GB model will cost Rs36,100. The same handsets in the US are cheaper. The 8GB model retails for US$199 and the 16GB model for US$299. So, people in India will think twice before they spend such large amount on the snazzy iPhone. Airtel claims 200,000 customers have registered for the iPhone, Vodafone has reportedly registered half this number.
India's inflation, based on the wholesale price index (WPI), climbed to a 16-year high in the second week of August, mainly due to rising food prices, raising concerns about a possible tightening of monetary policy over the next few months. The annual point-to-point inflation rose to 12.63% in the week ended August 9 from 12.44% in the previous week, the Commerce Ministry said. The WPI moved up marginally by 0.12%, to 240.7 from 240.4 in the week ending August 2. In the ‘Primary Articles’ group, the annual inflation increased to 11.83% from 11.43% reported last week. In the commodity group ‘Fuel & Power’ group, the rate of inflation at 17.99% remained unchanged at previous week’s level. Prices of all the 19 commodities remained unchanged. In the case of ‘Manufactured Products’, inflation increased to 10.91% from 10.75% in previous two weeks. Inflation rate for 30 essential commodities increased slightly to 6.74% from 6.54% in the previous week. Prices of these commodities, which include foodgrains, pulses, edible oils, vegetables, dairy products etc have more or less stabilised.
Investors can consider buying the Tata Steel stock trading at Rs 594, which is a price-earnings multiple of eight times its standalone earnings and about five times its likely consolidated earnings for FY-09 . The company’s integrated operations, access to captive raw material sources, high operating efficiency and wide geographical footprint are the key advantages.
Capacity expansion plans and strategic moves to secure raw material sources in a strong demand environment, augur well for volume growth and stability in profit margins. A global footprint enables Tata Steel to gain from growth opportunities and better pricing power in markets outside India.
On a standalone basis, Tata Steel derives 84 per cent of revenues from its steel division and the rest from products such as tubes, ferro alloys and minerals.
It now has capacity to produce five million tonnes (MT) of steel, which is slated to increase to 6.8 MT, as new capacities are commissioned by end-September 2008.
Tata Steel has set a target to achieve a capacity of 100 MT by 2015, through an equal balance of greenfield and acquired capacities. Greenfield expansions are to be carried out through integrated steel plants of 12 mtpa in Jharkhand, 5 mtpa in Chhattisgarh and 6 mtpa in Orissa. Forays into the titanium dioxide business in Tuticorin and Tirunelveli (Tamil Nadu), ferro-chrome plant in South Africa and setting up of a deep-sea port in Dhamra (coastal Orissa) are also on the anvil.
Tata Steel has aggressively pursued an inorganic growth strategy to add capacity. Overseas acquisitions have added to capacity in a big way — including Corus (20 MT), Natsteel (2 MT) and Tata Steel (Thailand), earlier Millennium Steel (1.7 MT). Tata Steel has been investing in those countries where the markets, coupled with the consumption of steel, have been growing. Its recent joint venture pact with Vietnam Steel Corporation and Vietnam Cement Industries Corporation to establish a complex in the Ha Tinh province in Vietnam may allow entry into a market, where consumption and imports have risen rapidly. Recent talks to sell the aluminium smelters of Corus show that moves have already been initiated to reduce Corus’ cost structure and peg up its profitability levels in line with the parent company.
Backward integration through captive sources of raw material place Tata Steel among the lowest cost producers of steel, globally. On the domestic front, the company sources 100 per cent of iron ore and 60 per cent of coking coal requirements from captive sources, largely insulating it from the hike in input costs. On the finished products front, over 70 per cent of the steel is marketed through negotiated long-term contracts.
This reduces the vulnerability of profit margins to the short-term changes in input costs as well as market prices of steel. These factors have resulted in earnings before interest, tax and depreciation and amortisation (EBITDA) margins of more than 40 per cent on the company’s standalone operations, with the company actually improving margins in the June quarter.
Tata Steel’s overseas operations are more exposed to raw material cost increases, as the acquired Corus facilities rely more on external sources of raw materials such as iron ore and coal.
Even the raw material security of standalone Tata Steel may come down to 40 per cent in the next three-five years with the expansion of the Jamshedpur plant and the Orissa facility going on stream. To address this, Tata Steel has identified raw material resources in the US, Africa and Australia for acquisition to ensure that around 50 per cent of the requirement for Corus is met through captive sources.
Strategic investments have been made abroad for various raw materials — low ash coal (Australia), coking coal (Mozambique), iron ore (Ivory Coast) and limestone (Oman). Presence in several overseas markets through its foreign subsidiaries, however, allows the company to benefit from rising global steel prices. Even if domestic prices continue to be held down by policy pressures, the company may be able to pass on input increases in its overseas operations.
The company managed a five-year compounded annual growth rate (CAGR) of 17.6 per cent in net sales and 35.8 per cent in profits. Operating profit margins rose from 2002-03 to 2004-05, declined marginally in 2005-06 and climbed back to 42.7 per cent in 2007-08. There was a substantial increase in the company’s size after the acquisition of Corus, with the net sales increasing from Rs. 25,212 crore (2006-07) to Rs. 1,31,535 crore (2007-08). By the close of April 2008, financing for the Corus acquisition was completed with bridge funding contracted for the acquisition replaced by a mix of debt, equity and internal accruals and the non-recourse funding syndicated during the year.
The company’s first quarter performance was strong with a 46 per cent increase in sales and 22 per cent rise in net profit. Segment-wise results show a 38 per cent increase in revenue in the steel division, while the ferro alloys and minerals division registered an increase of 163 per cent.
Risks and challenges
While demand prospects remain strong, the key challenges to Tata Steel’s earnings outlook arise from softer trends in global steel prices, any further policy intervention to curb domestic steel prices and the currency and other risks arising from significant overseas operations.
Domestic steel producers were asked to hold their price line for three months beginning May, and have again acquiesced to hold it for the time being, from the first week of August. Moreover, the Government recently asked the steel companies to cut prices in view of the softening global steel prices. Tata Steel too has held prices; but the impact of this freeze on its margins may not be big, given that only 30 per cent of its sales is pegged to open market prices.
Though the demand for steel, as for other commodities, may moderate if global economic growth slows (with India and China also reporting a slowdown), the price outlook for steel over the medium term is still quite bright, given the sizeable demand-supply gap. This will persist as the expansion projects now underway will take time to become operational.
Customized knowledge services company Boston Analytics released the Boston Analytics Consumer Sentiment Index (BACSI) for India results for the month of July. The past month registered a marginal 3.8% decrease in the BACSI, a monthly barometer of Indian consumer opinion regarding the current state and future expectations of the macro economy, household financial conditions and consumption.
The index is based on a monthly survey targeting a diverse set of demographics representative of Indian consumers. In an effort to capture the country’s heterogeneity, the BACSI’s July survey has been extended in terms of both geographic coverage and sample size with the inclusion of Hyderabad.
The survey is now conducted across five cities—Delhi, Mumbai, Kolkata, Chennai, and Hyderabad—targeting a diverse set of demographics representative of Indian consumers. It addresses macro-level variables reflecting the nation’s economic conditions, including indicators such as employment, inflation, interest rates and real estate.
The BACSI also studies micro-level variables such as household income, commitment towards expenditure on basic necessities (durables, automobile, and house), savings and other elements.
The BACSI for the month of June stood at 93.2, down 3.8% from the previous month’s reading of 96.9. Disaggregation of the data reveals that the primary drivers of the decline in consumer sentiment were decreases in respondents’ confidence in the economy and in employment conditions. Sentiment related to inflation remained pessimistic but improved relative to the June reading, most likely due to the government’s highly visible campaign to combat inflation. Despite the overall composite sentiment index trending down, the consumer spending component remained strong in July.
"It appears that overall consumer sentiment in India is trending lower in a gradual manner, unlike the dramatic declines in consumer sentiment being reported in the United States and Europe," said Sam Thomas, Ph.D., Boston Analytics’ director of research and development. "It is also notable that despite a worldwide slowdown in consumer spending, and continued concerns about inflation, Indian consumer attitudes toward spending remain optimistic, reflecting an upward trend in the BACSI since May."
After several months of war of words and legal wrangling over the contentious issue of gas supply, the warring Ambani brothers could be headed for an out of court settlement, provided their mother plays the role of the mediator once again. Anil Ambani's lawyers told the Bombay High Court on Aug. 21 that the younger of the Ambani siblings was ready to meet his elder brother Mukesh "anywhere, anytime" to resolve the long-standing dispute between the two groups.
The suggestion was made by Ram Jethmalani, the lawyer for RNRL during the course of arguments before the court over the controversial issue of gas supply from Reliance Industries’ Krishna Godavari basin to the Dadri power project in Uttar Pradesh. However, he added that Anil wants Kokilaben to intervene in the matter. It may be recalled that she had played a crucial role in dividing the Reliance group’s assets between the two estranged brothers in June 2005.
"We are prepared to have this particular issue decided by Kokilaben. They may meet with their mother without the lawyers," Jethmalani said. " The court can call both Mukesh and Anil to explore the possibility of an out-of-court settlement and Anil is willing to attend at a time convenient to the judges." Some weeks ago, Harish Salve, RIL's counsel had said the company is not the family property of the Ambani family and the court has no jurisdiction in altering the demerger.
"If you go by MoU approach, you will take RIL as the family property of the Ambanis. The demerger scheme was agreed upon by both the parties with open eyes. Any directions by the court in this regard will mean corporate democracy going to the dogs. The suitable arrangement must be found within the scheme and not outside it," Salve had said.
Tata Motors threatened to move the Nano car plant from West Bengal amid continued protests against the one-lakh-rupee car project. The investment of Rs15bn that Tata Motors has so far made in the Singur plant would not deter the company from relocating the plant to protect its employees from any violence, Chairman Ratan Tata told reporters in Kolkata. Maharashtra, Punjab and Orissa invited Tata Motors to set up the Nano plant in their states if the company decides to move out of West Bengal.
"If anybody is under the impression that because we have made this large investment of about Rs15bn, we will not move, then they are wrong. We would move whatever is the cost, to protect our people," Tata told reporters in the Oberoi Grand in Kolkata on Friday. "I've made a major investment here... to move will be at a great cost to Tata Motors and to shareholders. But, there is a concern about our people, a definite concern about not being wanted," he said.
"We don’t want anybody to leave West Bengal. But we aren’t really bothered whether the Tatas quit Singur," Trinamool Congress leader Mamata Banerjee said. Chief minister Buddhadeb Bhattacharjee requested all political parties to maintain harmony and allow the project to be set up in the interest of the state. "I am optimistic that the project will come up," he said. But, Banerjee is sticking to its plans for an indefinite siege at Singur from Sunday.
Her principal demand is the return of the 400 acres within the Nano complex. Local farmers, led by Trinamool Congress, allege that the state government evicted them forcibly and transferred what was fertile multi-crop land to the project for a song. The protests turned ugly as local Left supporters and farmers in favour of the project clashed with the protesters. Some 12,000 families have been affected by the project.
Tata Motors started to build its factory in Singur in January 2007 to make the world's cheapest car. The much awaited one-lakh-rupee car was unveiled in New Delhi in January this year and it was likely to hit roads by October. However, if Tata Motors does pull out of Singur, the launch could be delayed. What's worse, Tata Motors could lose around Rs5bn in the event of a relocation. Industry experts say a third of the investment in a car project is irrecoverable.