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Time for a break! - Views on News from Equitymaster
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  • Oct 23, 2004

    Time for a break!

    Its quarterly results time! Unlike the last quarter, the stock markets seem to be less euphoric in this quarter despite encouraging numbers on a broader basis. Firm crude prices, poor performance by select banking and second-rung tech companies and lower than anticipated margin expansion seems to be weighing on sentiments. We take a look at what happened last week and the shape of things to come?

    The market weakens…
    While the Sensex fell by 1.3% since October 14th 2004, the Nifty was lower by 0.8%. Amidst good corporate performances, factors like firm crude prices in the global market are weighing on the sentiment. Though inflation has cooled off from its high, the fact of the matter is that it is likely to be much higher than the initial RBI estimates.

    On the economy front too, the fiscal deficit target of 4.4% is unlikely to be achieved and given the rise in crude prices, the subsidy bill of the government will shoot up. We believe that the negative impact of the rise in crude prices has been under-estimated by the stock market for the following reasons:

    • Energy intensive sectors like commodities and manufacturing have witnessed a sharp rise in their costs. While costs have risen, given the competitive landscape, the prices have not risen commensurately. This partially explains the reason for the decline in operating margins for Bajaj Auto. Had it not been for the rise in crude and coal prices, Gujarat Ambuja’s operating margins would have been much higher. Watch out for margins in the forthcoming quarters! There will be surprises on the downside.

    • Besides corporates, the impact is likely to be even more negative on the economy. Since almost 70% of the domestic crude requirements are imported, the import bill will shoot up. Though there is a positive story on the export side also, watch out for the fiscal deficit numbers!

    • Since sectors like energy are regulated, the petroleum product prices (petrol, diesel and LPG) have not risen commensurate to the increase in crude prices. To that extent, the inflation numbers are not reflective of the broader scenario (more so on the consumer side). If the government increases prices, the impact will be reflected again in the inflation numbers.

    Top gainers…
    Company Oct 14,
    2004 (Rs)
    Oct 21,
    2004 (Rs)
    BSE Sensex 5,713 5,641 -1.3% 6,250 / 4,228
    Nifty 1,795 1,780 -0.8% 2,015 / 1,292
    IPCA Labs 642 746 16.2% 775 / 436
    Sterlite Optical 59 68 15.7% 86 / 31
    Chennai Petro 198 217 9.7% 220 / 69
    Bongaigaon Refinery 84 91 8.4% 99 / 42
    Dena Bank 24 26 7.8% 40 / 19
    Welspun Gujarat 41 44 7.5% 53 / 25

    Banks take a hit…
    As our Results Monitor shows, a number of companies have actually posted a decline in net profits in 2QFY05. This is especially true for the banking sector. In the last few years, banks that were flush with funds had parked significant sums in bonds and government securities market. With inflation moving up sharply in FY05, the yield on the 10-year paper (considered as the benchmark) moved up sharply. Since bond prices fall when interest rates go up, it had a negative impact on banks and the other income component declined noticeably. Since offlate this forms a substantial part of net profit for most of the banks, net profit for some PSU banks has plummeted. While none of the banking stocks are a part of the top five losers in the BSE ‘A’ group, it may change very soon.

    Top Losers...
    Company Oct 14, 2004 (Rs) Oct 21, 2004 (Rs) % change 52-week H/L
    BSE Sensex 5,713 5,641 -1.3% 6,250 / 4,228
    Nifty 1,795 1,780 -0.8% 2,015 / 1,292
    VisualSoft 159 128 -19.3% 275 / 109
    Mastek 371 329 -11.4% 388 / 189
    Satyam 406 371 -8.7% 410 / 250
    IPCL 214 196 -8.5% 241 / 106
    Orchid Chemicals 241 220 -8.5% 285 / 148
    Tamilnadu Newsprint 67 62 -8.2% 104 / 41

    Software - Wheat from the chaff
    It was also an eventful week for technology stocks. While the top-rung players like Infosys, Wipro and TCS posted impressive numbers for 2QFY05 backed by strong volume growth and stable billing rates, it was not the case with smaller players. VisualSoft posted a 31% decline in net profit in 2QFY05 and so did Polaris Software. We have always maintained that it is better to stick to the top-rung players when it comes to investing in tech stocks. As we go forward, investors will be able to differentiate wheat from the chaff. The reason being these players have proved that they can scale up their businesses and gradually shift their revenue-mix to high value-added services. Amongst niche players, Geometric posted good numbers.

    What next?
    The RBI is expected to announce its mid-term review of the economy and the monetary policy on October 26th, 2004. While debate is going on as to whether the RBI will increase interest rates or leave it untouched, the fact of the matter is that crude prices have risen. This combined with firm commodity prices is clearly reflected in the inflation numbers. The RBI, time and again, has maintained that economic growth with price stability will be its key objective. If not now, we believe that interest rates will be increase in the short-term and therefore, investors have to keep this factor in mind before taking their investment.

    Though the stock market has risen despite higher crude prices, it is will be very risky to assume that this time, the impact will not be that significant on corporates and on the economy. While bottom-up approach to investing has its own merits, we suggest investors to be cautious when it comes to investing in stocks. It is believed in the stock market circles that there is always a second chance!



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