‘Industrial recovery was stronger than expected’
ML: Why has the market so quickly discounted the impact of the monsoon?
VS: I think the monsoon is not a significant factor. When you look at data like monsoon is 20% less, how much does it affect the GDP growth? I am not an expert in this issue but it suggests to me that there is some kind of downside pressure on the economy coming through from agriculture. But I think the reason why the market has looked beyond is actually something else and that is essentially the fact that the industrial recovery has been far stronger then what we had anticipated. I mean six months ago our baseline view was that we would grow at a 6%-6.5% and while my baseline view has still not changed, that number frankly should be revised upwards given the strength in the industrial production. The only reason that it has not been revised upwards is only because of the weakness that we can eventually see from a poor monsoon.
 
ML: Domestic investors have poured more funds into the markets. Have we finally shrugged off our huge dependence on FIIs? If so, what are the long-term implications?
VS: Well, the rally was started more by foreign money. You can argue that the paper that was floating around was actually sucked out in the first place by domestic investors during late 2008 and early 2009. I think the bigger issue is that pretty much since 2007, the total domestic institutional buying—whether it is insurance, banks, mutual funds put together—has actually been more than what the foreigners have done. I think this is an important trend and it’s a trend that will at some level eventually sustain because at the end of the day the economy is growing in nominal terms at 10%-12% and incomes are growing and when incomes are growing investible surpluses are growing. They have to go somewhere. Obviously the asset class of choice much to our chagrin has been ULIPs over the last three-four years. Maybe it will be the New Pension Scheme in the next three-four years. Eventually this money has to find a home somewhere. If you say this money won’t go into the equities because the Indian investors are very risk-averse, I would argue it would equally end up creating an asset bubble, because the money would then flow into bank fixed deposits. Then we should not be discussing rate tightness; we should be discussing 5% rate for FDs. Eventually something has to balance out the equation and I think the pure fact that you are continuing to grow at nominal terms 12-14% GDP means that incomes are growing and disposable savings are growing and equities are bound to benefit.
 
ML: What are your expectations regarding corporate performance and which sectors do you see outperforming?
VS: I think the resilience has been more on the economic numbers rather than necessarily in earnings and particularly balance sheets. A lot of the pain which was not felt in the economy was recorded in the earnings and lot of the pain that was not recorded on the earnings was recorded in the balance sheet. Companies have done all sorts of accounting jugglery; they used the rules to their advantage to not take into account what they should have had on their P&L and all of that. Maybe the true extent of non-performing loans has also not been recorded in the system because the RBI gave a time-window to the banks. I don’t think the true extent of earnings damage has been captured fully in all the reported numbers. Having said that, in terms of a trend, the June quarter numbers were clearly a little bit of a surprise, but more because of cost-related issue rather than top-line. My sense is that the second quarter will be more of the same. Maybe the top-line is still going to look uneven but the bottom line will look much better, but by the time you get to the end of the year, the cost pressures are going to start catching up again. We already started having pressure on most cost items whether raw materials, salaries, fixed overheads all of them have started to inch back up again. It’s interesting that you actually saw some of the best operating margins that companies have ever recorded in the last eight years being reported in the June quarter, when we were just coming out of a recovery. I think at some level they will have to give out some of their margins back either because of the pressure of raw materials or because of competitive pressures. Margins cannot stay at these elevated levels for so long. But hopefully it may get replaced by some element of top-line growth by the time you get into the fourth quarter and that should be possible because on a year-on-year basis obviously your volume numbers should grow as per your expectations.

Our key preference remains for domestic consumption themes like consumer staples and consumer discretionary items. Not that they are absent of valuation issues but the valuation issues are across the market. Banking and finance companies too feel that credit growth is starting to recover. We are far more cautious about sectors that are more globally interconnected like the commodity space. We have been positive about IT but now valuations have gone up. But on a two-three year perspective, the IT business model will weather this downturn because the downturn in the western economy in this time is more consumer led rather than business led. The health of corporate balance sheets in the developed world is reasonably good. The financial system had a problem but that also has been largely put behind so I don’t think spending trends will really get badly affected.

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GlaxoSmithKline may buy 5% stake in Dr Reddy’s
UK-based pharmaceutical giant GlaxoSmithKline (GSK) is likely to buy 5% stake in Indian drug manufacturer Dr Reddy’s Laboratories Ltd for $150 million.
 
This is a marriage between Western makers of branded drugs and Indian generic producers. However, the acquisition will not give GSK any control over Dr Reddy’s as the proposed stake is far lower than the limit of 15% and does not invite any open offer to the public.
 
Both GSK and Dr Reddy's are in a winning situation. Dr Reddy’s could expand its product profile in the UK and Europe as it can tap GSK’s huge network. In 2008-09, Dr Reddy’s generic revenue increased by 51% to Rs4,979 crore whereas total sales grew by 40% to Rs6,945 crore. In addition, “Dr Reddy’s will have first access to innovative products of GSK in India,” says Sarabjit Kaur, VP, Angel Broking. GSK will also get access to a basket of generics at a time when a large numbers of drugs are going off-patent.
 
“The acquisition of 5% is more of a strategic policy,” says Mrs Kaur and the move is in line with Glaxo’s recent acquisition in Africa. Global multinational companies are under pressure to maintain market share as their patented drugs are likely to lose sales when they become generic. Multinational companies having low number of new discoveries have to invest in other generic companies to maintain sales growth.
 
Multinational sales from new launches are also coming down. GSK’s new launches have contributed to only 0.8% of total sales in 2008. Since there is a limit to new launches in patented drugs, GSK may have to opt for generic drugs for growth. In addition, the company has to increase its business in other emerging areas. Dr Reddy’s can fulfill both of these conditions and is an attractive opportunity for GSK. For Dr Reddy’s, in its total sales of Rs6,949 crore, Europe’s contribution increased by 16% to Rs 1,189 crore.
 
GSK, a £25 billion UK company, has a strong presence in drugs for asthma, HIV, malaria, depression, migraine, cancer, diabetes and digestive conditions whereas Dr Reddy’s has a strong presence in painkillers, gastrointestinal, antibiotics and heart depression drugs. The combination of these drugs will enable both companies to expand their therapy areas.
 
GSK has expanded its Chinese presence and is also spreading its wings in Africa. In May 2009, GSK bought a 16% stake in Africa's biggest generic drug maker, Aspen Pharmacare, for $465 million.

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Kingfisher Airlines surviving on “cash and carry” mode
While Bharat Petroleum Corp Ltd (BPCL) has come down heavily on Kingfisher Airlines on pending dues for jet fuel, repayments to various other entities for services has been an important issue with the airline over the past several months and it is running all its services on a “cash and carry” basis.
 
In a recent hearing on the jet fuel dues at the Bombay High Court, BPCL demanded a substantial amount to be given as the repayment of dues, against the monthly payment of Rs10 crore offered by the airline. Kingfisher owes BPCL around Rs314. 32 crore. Meanwhile, Kingfisher Airlines alleged that BPCL had not honoured the 90-day grace period granted by the Indian government to all airlines.
 
Kingfisher owes a total of Rs940 crore to state- run oil companies, including Rs37.40 crore to Indian Oil Corporation (IOC), Rs598.80 crore to Hindustan Petroleum Corporation Ltd (HPCL) and Rs314.30 crore to BPCL.
 
Along with BPCL, IOC too had put the airline on the “cash and carry” mode since February 2009. Similarly, the Airport Authority of India (AAI) had also disallowed any further credit to Kingfisher in July 2009 and had put all services to the airline on the same mode.
 
In the court proceedings held yesterday at the Bombay High Court, the BPCL lawyer argued, “They (Kingfisher) put us on “cash-and-carry” just a few minutes before planes were due to take off at various airports.”
 
Both BPCL and Kingfisher Airlines refused to comment on the matter since it is subjudice.
 
Last month, Kingfisher Airlines had to face a strike by its ground handling staff, reportedly for non-payment of ground handling fees at the Delhi Airport. However, the spokesperson said, “It was an issue between the staff at of the previous ground handling agency Kingfisher had, and the new ground handling agency that we have hired now. We have asked them to settle the issue in the labour court.”

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