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Do fundamentals really matter?

July 21, 2003

The 9th and 10th days of this month caused considerable excitement at the bourses.

On the ninth, we had Maruti Udyog Ltd, whose issue had elicited an overwhelming response in June, being listed.

Jagdish Khattar, the company's managing director, sounded the gong at the BSE, and it turned out to be a big media event. Those who were around came up with some profound statements which made for good TV bytes.

I, too, was into the act on a CNBC show opining about the company's listing price and where it seemed headed. I said that at around Rs 160 the stock held out trading promise though the fundamentals looked stretched. So, where does the promise come from?

Well, one look at the allotment pattern and it becomes clear that Divestment Minister Arun Shourie (who, according to me, was the single largest factor responsible for the success of the IPO) has understood the market dynamics better than most.

The decision to allot more shares to retail investors was not only a popular one, but a very shrewd one.

His strategy has ensured that the insatiate institutional appetite will manifest itself in buying whenever the stock declines, which, in turn, will provide a safety net of sorts to the retail investor.

It must also be understood that retail allottees of the MUL stock will do well to take at least part of the fairly handsome profits on offer.

Where does Maruti stand on a SWOT (strengths, weaknesses, opportunities and threats) analysis?

On the positive side, with Suzuki holding a 54 per cent controlling stake in MUL, one can expect a substantial reduction in costs with royalties and transfer prices being melted down.

This, in turn, could translate into significantly better financials for MUL in FY04. It is worth noting that Suzuki is planning to use MUL's Gurgaon plant as a research and development (R&D) hub for its Asian region activities.

Furthermore, Suzuki's engineering expertise and dominance in the small car segment world-wide could ensure that MUL remains the dominant player in the 'A' if not the 'B' segment even in the face of intense competition.

The proliferation of car loans on offer, too, should spur passenger car demand, which in turn could help MUL expand operations in markets where it is already dominant.

The concerns would include the dwindling position of MUL in the 'mind-space' of the Indian consumer, especially in the crucial 'B' segment where competition is growing rapidly.

Furthermore, to grow, MUL will need to launch new models at sporadic intervals, and the capital cost and resultant depreciation charge of these would initially impact its bottomline adversely.

The growing risk of non-acceptance of new launches in the marketplace further accentuates this risk which could manifest in yet another financial year like 2001, when the company's bottomline slipped into the red.

On the financial front, the losses notched up by MUL's group companies do not augur very well. Then, in the fast approaching post-WTO scenario, used cars will open up another avenue of competition and any threat to MUL's near monopoly status in the 'A' segment could adversely impact its prospects.

Finally, while Suzuki Corp is undoubtedly gifted on the engineering front, its marketing capabilities in the absence of the reassuring shadow of the government remains to be tested.

The long and the short of this SWOT snapshot is that at a forward price-earnings (P/E) multiple of 15 or thereabouts on estimated FY04 earnings at a price of Rs 160, the stock is already fundamentally stretched.

That is the micro-picture. But, a look at the macro-picture, which shows insatiate fund managers queuing up and eyeing the stock for pouching at declines, suggests that the stock could still have an upside. So, do fundamentals really matter?

In the second big event of the month, Infosys declared its Q1 results, which was hailed by the street as better than expected. After all, hadn't Infosys shell-shocked analysts last quarter?

In keeping with the market mood, the company's management also handed out a fairly optimistic guidance.

The projected earnings per share for this year now stand at Rs 168 rather than Rs 162, where it stood before the guidance.

This suggests that at the price of Rs 3,600 plus, which it touched on the day of its results, the stock is quoting at a P/E multiple of over 21.

Exactly three months ago, the bell-weather IT stock had vertically crashed on panic fund selling to around Rs 2,500, which translated into a P/E multiple of a little over 15 on the earlier EPS estimate for FY04.

Of course, bull market valuations always border on exaggeration, but surely, one quarterly result and guidance cannot change perceptions overnight. But then, perhaps it can, which again brings us to the moot question do fundamentals really matter?

The author heads Lotus Strategic Consultants, Mumbai. The author has no outstanding interest in the stocks discussed in the column.

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