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At the pinnacle! - Views on News from Equitymaster
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  • Oct 14, 2006

    At the pinnacle!

    The previous week saw the Indian indices hitting their much-anticipated record highs, as weakening crude oil prices, strong industrial production data and block-buster results announced by tech major Infosys lent them significant momentum, particularly towards the second half of the week. The BSE Sensex this week crossed its previous record high of 12,671 hit in May this year, and also closed at an all-time high level. The Sensex now trades at 21.8 times its trailing 12-month earnings, making it amply clear that market expectations from India Inc are high, and there is no room whatsoever for any disappointments on the earnings front. With Infosys having set the ball rolling with a sterling set of numbers announced on Wednesday, this has set the bar at particularly high levels, not just for the other tech companies due to announce their results in the next week, but also for India Inc in general. For the week, the BSE-Sensex gained 2.9%, while the NSE-Nifty gained 3.0%.

    Coming to the trade for the week, Monday saw a volatile session of trade, as the indices swung like pendulums either side of last Friday's closing levels. The volatility, which was a feature of the previous week's trade, continued even on Monday, and this was also partly due to weaker Asian indices, which traded lower in response to the reported nuclear tests carried out by North Korea. Eventually, the indices closed Monday flat. Tuesday, on the other hand, saw a strong start, and with the notable absence of any volatility, a feature of recent trading sessions. However, with each trading hour, profit booking saw the indices completely pare their gains towards the close.

    Come Wednesday, the start was buoyant, as was the case on Tuesday, powered mainly by software stocks, which witnessed a vertical lift-off due to the strong results posted by the 'technology bellwether', Infosys. However, again, just like in Tuesday's trading session, the indices lost ground towards the close and ended slightly in the red, as profit booking was witnessed at the higher levels. However, on Thursday, the indices lifted off, aided partly by strong IIP numbers reported, even as the start was fairly subdued. Friday saw the Sensex finally breach its all-time high levels in early trades, and the bulls gave no quarter, with the close being the highest-ever in the history of the benchmark index.

    As far as the institutional activity on the bourses was concerned, Foreign Institutional Investors (FIIs) were net buyers this week to the tune of Rs 14.6 bn. Domestic mutual funds (MFs), on the other hand, turned out to be net sellers to the tune of Rs 109 m.

    Net investments
    (Rs m) FIIs MFs Total
    6-Oct-06 710 1,168 1,878
    9-Oct-06 (457) (817) (1,274)
    10-Oct-06 964 (1,086) (122)
    11-Oct-06 8,034 1,002 9,036
    12-Oct-06 5,393 (377) 5,016
    Total 14,644 (109) 14,535

    The BSE Sensex, the benchmark index, closed higher during the last week by 2.9%, while the NSE Nifty gained 3.0%. As regards sectoral indices, this week, it was clearly the BSE IT index that hogged the limelight, gaining as much as 9.0%, buoyed by the exceptionally good numbers reported by Infosys, which has an over-50% weightage in this index. Infosys, not co-incidentally, was one of the major gainers last week, gaining as much as 11.6%. The BSE Oil & Gas index proved to be another gainer this week to the tune of 1.6%, aided surely in some way by falling crude oil prices. The BSE Healthcare index also managed to gain 1.0%, while the BSE Small-cap index managed to add 1.4%. The other indices also managed to record some gains, though not that significant. Thus, it is clear that it was the software sector that was the star performer this week, and given the brilliant performance recorded by Infosys, the outlook for the sector appears brighter than ever. We are positive on the top-tier companies in this space, and only on a select few mid-sized, niche players. On the flip side, major risks in our view would include HR issues and attrition rates, and the increasing competitive intensity in the sector.

    Key indices over the week
    Index As on October 6 As on October 13 % Change
    BSE AUTO 5,472 5,502 0.6%
    BSE BANKEX 6,080 6,107 0.4%
    BSE FMCG 2,028 2,036 0.4%
    BSE HEALTHCARE 3,623 3,658 1.0%
    BSE IT 4,401 4,797 9.0%
    BSE METAL 8,687 8,691 0.0%
    BSE OIL&GAS 5,815 5,906 1.6%
    BSE PSU 5,864 5,884 0.3%
    BSE MIDCAP 5,264 5,288 0.5%
    BSE SMLCAP 6,329 6,417 1.4%

    Having looked at the institutional activity and the movement in key indices in the last week, let us consider some sector/stock specific developments:

    • 'Technology bellwether' Infosys kicked off the 2QFY07 earnings season last week, announcing its financial results for the second quarter and half-year ended September 2006 on Wednesday morning. Impressive volume growth, aided by the ever-increasing adoption of offshoring by global corporations, and continued expansion of service lines led to a power-packed performance on the topline front. Margins saw strong expansion due to cost management and SG&A leverage. The margin expansion led to an impressive sequential growth in net profits, despite considerably lower other income. For the half-year, the performance has been excellent. The board has declared an interim dividend of Rs 5 per share (dividend yield of 0.24%). As was the case in the previous quarter, the management has again increased its guidance for FY07, and now expects revenues to grow at a rate between 45.5% and 46% YoY to hit Rs 138.5 bn to Rs 139.0 bn, while the earnings per share (EPS) is expected to hit Rs 66, a YoY growth of 46.6%. The stock closed the week higher by 11.6%. Other software stocks.

    • Eastern Silk Industries, the second largest exporter of silk garments and fabrics from the country, reported enthusing results for the half-year ended September 2006 on Monday. The company clocked a 28% YoY growth in topline and a 63% YoY growth in bottomline for the said period. Eastern Silk has embarked on various initiatives such as capacity expansion, forward integration and greater market reach. The company is expanding fabric capacity and also setting up facility for made-ups, which will use almost the entire expanded fabric capacity. The operating profit margin has also increased by 400 basis points (from 17% in 1HFY06 to 21% in 1HFY07) due to higher share of machine-made fabrics and made-ups as also savings in raw material cost. The company expects sales contribution from made-ups to increase from 9% in FY06 to 20% in FY08. The stock closed the week higher by 5.8%. Other textile stocks.

      Top gainers during the week (BSE-A)
      Company Price on
      Oct 6 (Rs)
      on Oct 13 (Rs)
      H/L (Rs)
      BSE-SENSEX 12,373 12,736 2.9% 12,756 / 7,656
      S&P CNX NIFTY 3,570 3,676 3.0% 3,774 / 2,307
      HINDUSTAN ZINC 593 718 21.1% 1,119 / 202
      IGATE SOLUTIONS 190 227 19.4% 284 / 145
      INFOSYS 1,872 2,089 11.6% 2,100 / 1,201
      TCS LTD. 993 1,105 11.2% 1,120 / 676
      STERLITE OPTICAL 172 191 10.5% 196 / 73

    • Tractor and UV major, M&M, has forayed into the Iranian market through an alliance with Iran's largest tractor manufacturer, Iran Tractor Manufacturing Co (ITM). As per the terms of the deal, M&M will supply tractors through ITM's channel in Iran, with the operations set to commence later this month. This move will help M&M get a footprint in the Iranian market. It should be noted that the larger intent of this move is to eventually look at localisation and the development of tractors ideally suited for the local conditions in Iran. M&M's stock closed the week lower by 0.9%. Other auto stocks.

      Top losers during the week (BSE-A)
      Company Price on
      Oct 6 (Rs)
      Price on
      Oct 13 (Rs)
      H/L (Rs)
      MIRC ELEC. 29 25 -12.0% 30 / 14
      MOSER-BAER INDIA 240 225 -6.1% 268 / 162
      ORIENTAL BK. 269 254 -5.6% 295 / 139
      PIDILITE INDUSTRIES 112 106 -5.5% 123 / 69
      EIH LTD. 107 102 -5.2% 127 / 53

    • Reliance Petroleum has signed a deal with a consortium of 14 international banks for a loan of US$ 2 bn to finance expansion at its Jamnagar refinery. This is a part of the US$ 3.5 bn debt that the company was planning to pick up for the refinery. Of the total cost of US$ 6.1 bn, US$ 3.5 bn is debt and US$ 2.5 bn, the equity component. The present loan of US$ 2 bn is 33% higher than the originally planned US$ 1.5 bn loan. The company plans to expand its existing 660,000 barrel-a-day refinery. The new project will be located next to the existing refinery and will be able to process 580,000 barrels of oil a day and 900,000 tonnes a year of polypropylene. The stock closed the week lower by 1.9%. Other energy stocks.

    With the BSE Sensex now at its all-time high levels, the question arises as to what investors must do now. We firmly believe that what is more pertinent for any stock investor is not what level the benchmark index trades at, but at what valuations the individual stocks trade at. At current levels, we believe that a bottom-up approach is the best way to make money in equities. We have said that the Sensex's current valuations at 21.8 times trailing 12-month earnings are not cheap by any means, and we have held this view for quite some time now. Undoubtedly, Corporate India has strong growth prospects - that is not the question. The question is, how much should an investor pay for this growth? We believe that, at least in the near-term, most of the upside has been factored in, and unless the companies that are still due to announce their results show a significant outperformance as was the case with Infosys, an upward re-rating is not warranted.

    The next week will be witness to some major corporates announcing their results, such as TCS, Wipro, Satyam, Bajaj Auto, Bharat Forge, HDFC Bank and HDFC. Thus, the near-term trend, as we have been saying for the last couple of weeks, is likely to be determined by the kind of numbers that these major companies throw up, and with the bar being set by Infosys, it will be a none-too-easy task to live up to heightened market expectations. As we have been saying for some time now, we continue to believe that there are greater opportunities in select mid-cap stocks at the current levels. As always, do your homework thoroughly before taking an investment decision. At the end of the day, it is your hard-earned money that you have to invest, and if you yourself are not convinced about the story, then you might not sleep peacefully at night! Happy Investing!



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