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November 25, 1999


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Devangshu Datta

Why some lose more than others

Eighty up, twenty down. That's the Diwali grid for the snakes-and-ladders game of returns on the BSE100. This is an index of the hundred largest companies in the country. Over 55 per cent of the stock market's value are invested in these stocks. So it's a good representative sample of the corporate world.

Eighty of the 100 scrips featured in the BSE100 Index are up. The arithmetic average return is over 85 per cent in what has turned out to be the best Samvat since 1993-94. Last year around this time, the market was heading for a Sensex floor level of 2741 points; this year it is correcting off a recent high at 5150 points.

The big market performers include the incredible Infosys Technologies (+633 per cent) and Zee Telefilms (646 per cent). There are also a clutch of high-flying pharma firms like Cipla (308 per cent), Ranbaxy (233 per cent) and Wockhardt (133 per cent), as well as the usual suspects from the infotech industry like Satyam (437 per cent) and Wipro (195 per cent). There are few surprises in this list for these two sectors have done well, come hell or high water.

But many extraordinary gains have been registered in cyclical industries, which does imply that the market is betting on a sharp upturn in the business cycle. Cement majors Gujarat Ambuja (211 per cent), Grasim (227 per cent), ACC (175 per cent) and L&T (180 per cent) have all rewarded punters. Paper major BILT has seen its share price up 248 per cent. Ashok Leyland (355 per cent), Telco (135 per cent), M&M (123 per cent) have all been big winners. So has Sail (141 per cent) and Tisco (90 per cent). Reliance Industries and Reliance Petrochem are both up over 100 per cent as well.

In several of these cases, hype and expectation is clearly ahead of the fundamentals. Sail has had a disastrous first half, for example, while Telco has just pulled out of recession. Of course, cement has done well with the industry recording a sharp increase in off-take. But the phenomenon of price lines jumping well before results justify the new valuations is explicable. The stock market is, as always, looking into a crystal ball that may, or may not, be flawed.

In the midst of all this good cheer, I thought it would be more interesting to look at the losers. After all, India doesn't really have too many industries that are classifiable as clearly counter-cyclical. The systemic risk is considered low at the moment, so under-performance could either be a function of inaccurate valuation or a company-specific problem.

The market has a good reason for hammering most of these scrips. ABB, Arvind Mills, Bajaj Auto, Bank of India, Bata, Carrier Aircon, Crompton Greaves, East India Hotels, GSFC, IDBI, Indian Hotels, Phillips, Smithkline Pharma and Tata Chemicals have all delivered poor or lacklustre results in March 1999 and also September 1999. In various cases, profits have dropped, income has dropped, interest costs are up, marketshare is down: so punters are pulling back.

GSFC and Tata Chemicals have an industry specific problem -- the fertiliser and (for Tata Chem) caustic soda/ash chlorine businesses are low-growth, low-margins and low future. Supply will overhang demand in the next 3, 4 years. There is no reason for investors to salivate.

EI Hotels and Indian Hotels also have a simple sensitivity to recession affecting occupancy rates. Variable cost in the hospitality industry is around 25 per cent, so occupancy is critical. That has been down through the last couple of years. If the economy really picks up and tourist as well as business visitations rise, both companies will bounce back swiftly. If one also factors in inevitable rupee depreciation, the luxury hotel segment could already be under-valued.

ABB and Crompton Greaves are both companies in a potentially high-growth area. The power sector has been stymied by political indecision about liberalisation of transmission and distribution as well as clearances and financial closures for various independent power projects. There is also the chronic insolvency of state electricity boards to contend with.

Crompton is slap-bang in the midst of a big restructuring and a lot hinges on its anticipated sell-off of the Skycell telecom licenses which could fetch perhaps Rs 250 crore. It had terrible first-half results with increasing losses. ABB was better off and it does not have the same restructuring problems and also possesses a parent with global brand equity. But the power sector itself has a lot of question marks attached as to future direction.

Cochin Refineries and HPCL are a different kettle of fish. Refinery margins are up and both companies have delivered decent results. Both have completely depreciated plants and stand to benefit hugely from the continued liberalisation in this sector. In 2002, product pricing will be freed and marketing margins will also be loosened in 2003.

In Cochin Refineries's case, the market is unhappy about the prospect of the single-refinery company being merged into a new entity with several other, less efficiently-run companies. In HPCL's case, analysts are unhappy about the steady loss of market share to rival public sector, BPCL. There is another looming problem in that HPCL mainly refines heavy and middle distillates. These are lower margin and have higher pollution counts. Some observers fear that further environmental legislation could force HPCL into a very expensive re-jigging of its refineries. But these two companies still look undervalued given the future prospects and the high-entry barriers for new players.

In Nalco's case, the company is still recovering from a plant breakdown last year. Aluminum prices have been rising globally, but fairly slowly. There is also the problem of a huge equity base of Rs 1,288 crore, which will always depress earnings.

SmithKline Pharma owns market leading brands such as Iodex (pain balm) and Crocin (which was acquired from Duphar). But the company has suffered poor results this half-year; interest costs have risen sharply and volumes have stagnated. It is even more starkly obvious since the zero-debt company used to have the highest return on capital employed in the industry. The other problem is that SmithKline now has a hundred per cent subsidiary operating in India. The market expects new products to be introduced through that route, starving the listed SKPL.

Tata Infotech is an apparent surprise -- after all, investors normally blindly buy software stocks. The problem here is that the company under-performs the industry. Growth rates and profit margins as well as earnings growth rates are lower than expectancy. This half-year has seen a fall in profits and revenues. TI also has a perceived over-dependence on erstwhile partner Unisys for its international business. It also has a very high employee churn rate. The stock has never quite piggybacked the IT wave successfully. So again, the price-drop is understandable.

Devangshu Datta

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