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On a platter...

Jun 3, 2006

Given the decline accompanied by the volatility, the stock market movement in May 2006 has shaken the investing community. Some view this volatility as a reality, some have exited the market but some (smart) investors have utilized this decline to their advantage by buying stocks for the long-term. What led to this correction has been discussed threadbare by the media and experts. Here is our take on the same. Except for the sharp rise in Friday, the markets had nothing going 'for' in the last week. Global markets continued to exhibit volatility. The release of the May 10th 2006 US Federal Reserve meeting minutes also gave mixed signals to the global investing community. Even as the broader US economic date continued to emit positive signals, the central bank is worried about inflation and inflationary expectations. To put it simply, it seems that more interest rates hikes are on the anvil. Added to this, the 10-year US yield was also volatile. Meanwhile, despite mixed opinion within the OPEC members on reducing crude output, the OPEC decided to maintain crude output at 28 m barrels a day and consequently, crude prices maintained status quo.

As far as the Indian economy is concerned, while the ruling government and the coalition were 'busy' discussing whether to hike petroleum product prices or not, the Indian economy recorded more than 9% GDP growth in the first quarter of the calendar year. This was largely on the back of a sharp jump in the agricultural sector. This is indeed a commendable show. Meanwhile, Rupee fluctuated significantly against the greenback on the back of FII selling as well as increased government borrowings. But towards the end of the week, as per forex experts, dollar inflows improved.

As far as the institutional activity on the bourses is concerned, as we had mentioned earlier, Foreign Institutional Investors (FIIs) were net sellers this week too (to the tune of Rs 28.1 bn). Domestic mutual funds (MFs) continued to utilize the decline to reduce the cash holdings in their portfolio (net buyers to the tune of Rs 13.6 bn). The selling by FIIs was not just restricted to India but it was the phenomenon in emerging markets in totality.

Net investments - Contratrians in action…
(Rs m) FIIs MFs Total
25-May-06(16,328)4,087 (12,241)
26-May-06 (2,527)2,228 (299)
29-May-06(818)1,451 633
30-May-06 (83)2,675 2,592
31-May-06 (8,323)3,204 (5,119)
Total(28,079) 13,645 (14,434)

While it is a known fact that the benchmark BSE-Sensex declined, what is more important to understand is that some sectors have outperformed the benchmark. The table below highlights the change in sectoral indices over the last week. Clearly, the midcaps have witnessed significant erosion in market capitalization in the last one week closely followed by the BSE FMCG index. The sharp decline in FMCG stocks (considered defensive) is a surprise and highlights the extent of panic in the market. The technology index (BSE IT) outperformed the benchmark by declining lesser on a relative basis! The recent depreciation in the rupee is broadly a positive for software services companies in India.

Key indices over the week
IndexPrice on
May 26 (Rs)
Price on
June 2(Rs)
BSE Small-cap5,168 4,873 -5.7%
BSE Mid-cap6,558 5,986 -8.7%
BSE METAL8,920 8,573 -3.9%
BSE HEALTHCARE3,503 3,356 -4.2%
BSE PSU5,479 5,216 -4.8%
BSE IT3,695 3,618 -2.1%
BSE AUTO4,967 4,774 -3.9%
BSE OIL&GAS5,223 5,081 -2.7%
BSE BANKEX4,991 4,843 -3.0%
BSE FMCG2,028 1,895 -6.5%

The last week also witnessed corporates announcing their full year results. While BHEL surprised the stock market on the positive, Tata Chemicals' performance was short of expectations. One of the biggest positive to have emerged from BHEL's FY06 performance was the sharp expansion in operating margins, which have jumped from 14.9% in FY05 to 17.6% in FY06. At the same time, the likes of EIH, ING Vysya Bank and many smaller company performance was mixed.

Top gainers during the week (BSE-A)
CompanyPrice on
May 26 (Rs)
Price on
June 2(Rs)
H/L (Rs)
BSE-SENSEX 10,809 10,451 -3.3%12,671 / 6,647
S&P CNX NIFTY 3,210 3,091 -3.7%3,774 / 2,061
BHEL1,937 1,993 2.9%2,500 / 811
M&M 591 599 1.3%724 / 250
HDFC1,176 1,179 0.2%1,420 / 755
HCL TECH 508 509 0.1%708 / 353
RANBAXY 425 426 0.0%568 / 339

Having looked the institutional activity and select corporate result announcements in the last one-week, let us consider some sector/stock specific developments:

Domestic pharma major Wockhardt is aiming to acquire biotech companies in the US and China. The company is in talks with four research-based biotech companies in China and three bio-pharma companies in the US for this purpose. Wockhardt is focusing on the innovative technologies developed by these companies along with facilities and talents. It must be noted that amongst Indian pharma companies, Wockhardt is a leading player in the biopharmaceuticals space. Its bio-pharma manufacturing facility has the capacity to cater to 10% to 15% of the global demand for major biopharmaceuticals. Therefore, if these acquisitions materialise, Wockhardt's biotech portfolio will be strengthened further. The stock closed with 5% losses during the week. Other pharma stocks

Madras Cements plans to set up a greenfield cement plant in Tamil Nadu with a capacity of 2 million tonnes (MT) per annum at a cost of about Rs 6 bn. Currently, the company has a total capacity of 6 MT and caters exclusively to the southern markets, with Kerala and Tamil Nadu being its principal markets. It controls 14% of the total cement capacity in the southern region. The company is also planning to set up an additional clinkering facility at its existing factory at Jayanthi Puram, Andhra Pradesh leading to an increased cement capacity of 2 MT per annum at a cost of about Rs 4 bn. Both the projects are slated to become operational in FY08. With the growing demand for cement due to the construction boom, these capacity expansion plans will enable the company to increase its market share. The stock closed 9% down during the week. Other cements stocks

Top losers during the week (BSE-A)
CompanyPrice on
May 26 (Rs)
Price on
June 2(Rs)
H/L (Rs)
SYNDICATE BANK77.7564.15-17.5%104 / 53
HIND ZINC698.8576.6-17.5%1,119 / 141
ORIENTEL BANK222.5187.05-15.9%297 / 176
WARTSILA INDIA377321.65-14.7%533 / 320
REL ENERGY531.3457.4-13.9%706 / 440

HCL Infosystems, India's leading hardware company has entered into a strategic alliance with Apple to provide sales and service support for iPods in India. As part of the agreement, HCL will set up distribution, logistics and service network to ensure availability of Apple iPods at key retail channels, including music shops and consumer electronic stores. HCL would also distribute Apple desktop computers for education, media and entertainment space. This alliance is a positive for the company as it is expected to strengthen its existing digital lifestyle product portfolio, which includes Media Centre PCs, laptops and mobile phones. Software stocks

FMCG behemoth, HLL, is looking at its branded foods segment to gain foothold in new markets. This is because the profitability of the company has been affected in recent times owing to lack of adequate infrastructure facilities in the food processing sector. HLL is uniquely positioned to capture the opportunities in branded foods segment as the company has a deep understanding of consumers, differentiated brand portfolio, innovation and execution capabilities to straddle the pyramid. The stock closed with 1% losses during the week. Other FMCG stocks.

The NSE Nifty is currently trading at a price to earnings multiple of 17.3 times FY06 earnings. Assuming that earnings should grow by 15% per annum over the next two years, the P/E multiple based on FY08 earnings stands at 13.1 times, which in our view is attractive. As an investor, one can adopt one of the following strategies:

  1. Wait for the 'dust to settle', as many market participants (including some domestic funds) are calling it.

  2. Utilize the decline to one's advantage. The fact remains that between May 1st 2006 and May 31st 2006, the outlook on fundaments i.e., corporate earnings growth, interest rates and inflation has not changed so dramatically that equities have suddenly become 'very risky'. We have always maintained that equities are a risky asset class, irrespective of whether it is a bull market or a bear market. So, if one can find good companies, plan atleast two-year investment horizon, invest and most importantly, stay put.

We believe that the latter is a better investment strategy at current levels. Happy investing!

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