Only Sniffing ...

The Indian market has delivered extraordinary returns over the past five years. But it has also put off many people who have either taken leveraged bets at the wrong time or have panicked and exited after sharp declines. In the past four years, trading was halted four times after a steep fall, each of these instances turned out to be an extraordinary buying opportunity. This is leading many commentators to suggest, once again, that the market is now a ‘screaming buy’. That is wisdom by hindsight and dubious at best. Two out of the four times, the market crashed because of local political and policy factors and on two other occasions due to global factors. Both sets of events are outside the control or anticipation of investors, regulators, companies and market intermediaries. The real test would be to check what politicians and policy-makers do when the market slides due to purely local reasons. Are we headed for  such a test now?

Bull markets lead to a period of huge excesses and are, therefore, predictably followed by bear markets. In bear markets, prices keep grinding down for years – especially if policy-makers and politicians don’t have the right prescriptions. And when was the last time we used the right prescription on facing a slowdown? Indeed, we have got so used to the idea of a perpetual bull market and a fast-growing economy in the past five years that there is little discussion about what could go wrong.

Markets around the world are not so blissful. All European and American indices have dropped well below 20% from their peaks which some argue is the technical definition of a bear market. Investors there don’t trust earnings forecasts made by analysts. European stocks are trading at price-to-earnings levels which indicate that the markets are pricing in recession-like earnings. According to a note sent by Morgan Stanley, “Our themes continue to be: patience, earnings recession, US recession spreading globally, a bear market regime, not being lured into value stocks as most of them are likely to be value traps and much more monetary easing. We expect flat but volatile markets just as in 1989-92 -- a real whipsaw environment for the market.”

What a far cry from the Indian situation! Indian fund managers and brokers have nothing but bullishness on their minds. Although their enthusiasm is somewhat dented by the recent crash, they are coming in a procession on television asking you to go out and buy stocks because they are cheap on the basis of 2009 earnings expectations. A US slowdown will lead to a sharp contraction in earnings everywhere which is not factored into Indian stock prices today. Once a slowdown scenario sets in, you will see aggressive changes to forecasts and a reduction of P/E through serious price declines.

We are neither predicting a recession nor a bear market for India at this time. Buying stocks after a crash -- an idea popularised by the media and brokers -- may not be a great idea any more. They are not the best forecasters. Fund managers too have a mandate to remain invested at all times. They hardly have any interest in speaking their mind, even if they are actually bearish. There is a theory doing the rounds that if the US economy is in a recession, India will get more outsourcing work. As a corollary to the same logic, there is a notion that if the US markets are down, American savings will come into India. These are dangerous ideas. They are totally untested. It is time to be cautious. The bear is sniffing all around the world. The US economy has a lot of work to do to get out of its mess. Until it does that, stocks would give poor returns globally.

If you must buy now, consider the following stocks. They are a mix of growth and value stocks and should be able to navigate better through a sluggish environment. However, we must make it clear that we are not recommending these stocks like we normally do. Our sense is that the environment is turning treacherous and it would be unwise to extrapolate past performance as everyone seems to be doing.

In uncertain times like these, common-sense investing demands that you buy strong large- or mega-cap stocks as these have better prowess to withstand an economic downturn and selling pressure, as opposed to mid-, small- and micro-cap stocks. What follows is a list of stocks that are either on a firm growth path or are valued reasonably.

What Really Happened?

What do the American president and the French central banker have in common? Well, the Americans and the French have no love lost for each other. But George Bush and Christian Noyer just may have helped global stock markets go over the precipice on 21st  and 22nd January.

Stock markets around the world have been weak for months now. Since August last year, one bank after another has been declaring losses due to its exposure to poor-quality home loans (subprime mortgages). Every few days, yet another bank has been confessing to a large loss. On Monday, 21st January, BNP Paribas suddenly announced that it would write off a huge $4.8 billion because of losses from US subprime mortgages. Bank of China is also writing off billions of dollars. It seems never-ending, a slow train-wreck and everybody seems to be in the dark about where it would stop. And, if there is one axiom about financial markets it is this: when the market players cannot see clearly, they do only one thing -- sell.

But what truly pushed the market into a free fall was a $150 billion fiscal stimulus plan of George Bush on Friday 18th January which, by common consensus, was too ineffectual. Then on the same day, came an innocuous comment by Christian Noyer, governor of the Bank of France and a member of the European Central Bank’s governing council. Noyer told International Herald Tribune, “I’m reasonably confident that French banks will weather this turmoil without major trouble even though they are clearly, like all banks in the world, still in the process of marking down assets.”

A nervous market, suffering from poor visibility and disappointed by the Bush package, latched on to Noyer’s comment about ‘marking down assets’. The first version of the story -- which no longer appears in IHT's online edition -- said he was assessing balance sheets of Societe Generale and BNP Paribas. From Monday afternoon, markets around the world went into a free fall. In India, this easily got compounded by panic selling of players in derivatives whose mark-to-market losses ballooned. What made it worse was the poor quality of scrips which the regulator has been pushing into the derivatives segment. These scrips have no buyers and can fall 50%-70% in just a few days.

boom in construction and infrastructure development. Rising volumes and a stable pricing environment have seen margins swell for most companies. Add to this, a diversified presence in other businesses which are likely to do well in future and you get a company which, in all probability, is a good bet for an uncertain market -- Kesoram Industries, flagship of the BK Birla group. Kesoram has a presence in cement, tyres, rayon, spun pipes and chemicals. Its revenues have risen by an average 38% over the past five quarters but more important is the growth in its operating profits which have been rising by a stupendous 222% over the past five quarters. Its margins have averaged 18% and these strong fundamentals are well supported by a decent valuation. Currently trading at Rs470, its market-cap discounts its five-quarter average sales (annualised) by just about 0.88 times and its operating profit by 4.71 times. Kesoram’s cement business is likely to do well on the back of a strong demand from the construction and infrastructure sectors. With new products lined up in the auto segment, especially in passenger cars, its tyres business too is expected to do well. Another business where the company is likely to see a fairly decent growth is spun pipes, thanks to a rising demand from the oil & gas and infrastructure sector.

Gujarat Gas, controlled by British Gas, is into natural gas distribution, building of gas distribution networks for transmission of natural gas and CNG retailing through gas stations. Natural gas is fast evolving as the best alternative to expensive fuels like petrol and diesel. This company has a proven capability of building natural gas distribution networks. How does it score on fundamentals? Its revenues have been rising by an average 42% over the past five quarters while its operating profit was up 55% over the same period, backed by an operating margin of 19%. Its stock is currently trading at Rs315 – a price at which its market-cap discounts its five-quarter average sales (annualised) by 1.98 times and its operating profit by 10.01 times. It is not expensive for the strong and steady growth it offers. The only problem is that gas transmission networks will come to be dominated by the Ambani brothers and Gujarat Gas will remain a player confined to just one state.

Its revenues have been rising by an average 34% over the past five quarters while its operating profit was up 48% over the same period. Its margins average a solid 28% and the stock looks slightly pricey at current levels compared with the others. At a price of Rs701, the market-cap of Dredging Corporation is 3.28 times its five-quarter average sales (annualised) and 11.65 times its operating profit. Why then do we feel that it is a good buying opportunity? It has a strong foothold in a business where competition is rare. Dredging is one of the most important activities for the maintenance of basic infrastructure of ports and DCI is almost a monopoly player.

Among other stocks to consider following the carnage are Opto Circuits, Praj Industries, Yes Bank and Tanla Solutions. The revenues of Opto Circuits have been rising by an average 77% over the past five quarters while operating profit was up 90% over the same period. Its operating margins average a fat 38%; this strong growth is why we think it is worth paying a higher price. The stock is trading at Rs460 which means a market-cap to sales ratio of 15.72 and a market-cap to operating profit ratio of 41.26. Praj Industries (whose promoter Pramod Chaudhari we have interviewed in this issue) is another growth story. Its revenues have been rising by an average 117% over the past five quarters while its operating profit was up 207% over the same period. Its margins average 15%; the stock is highly priced with its market-cap discounting its five-quarter average sales (annualised) by 4.40 times and its operating profit by 29.08 times. Among others that score well on growth parameters are Yes Bank and Tanla Solutions. Both companies are reporting a robust increase in revenues and operating profits growing with strong margins. On the valuation front, these may appear pricey but the growth story is strong enough to support expensive valuation of these stocks.

Another mega-cap company from the Birla stable worth looking at is from the Aditya Birla group. Hindalco Industries Limited combines fairly good fundamentals with an attractive valuation. Its revenues have been rising by an average 37% over the past five quarters while its operating profit was up 36% over the same period. The company’s margins have averaged 21% over the past five quarters; currently trading at Rs166, its market-cap discounts its five-quarter average sales (annualised) by 1.08 times and its operating profit by 5.25 times. Will its growth continue? Hindalco has a completely integrated presence in aluminium and copper with mines of its own. It is the world’s largest aluminium rolling company and among the biggest producers of primary aluminium in Asia. Its copper unit is the world’s largest single-location custom copper smelter with the capacity to manufacture 500,000 tonnes per annum. Captive power and oxygen plants, a captive jetty and access to raw materials through the mines it owns offer the company a unique advantage of keeping its costs low and improve its margins. At a time when the market is focused on finding value amidst the mayhem, a strong pedigree is one factor that influences investor sentiment. Hindalco definitely scores well on this front.

Rates, Recession and Recoupling

If the central bank of a country meets for an emergency session a week before the scheduled official meeting and cuts interest rates, the conclusion is clear: the country is in deep economic trouble and things are worse than they seem.

However, what if you throw a party and nobody comes? In other words, what if even a deep rate cut does not help the economy and the markets? Remember that the Fed has been on a rate-cutting spree for a while now and things have gone worse for US consumers. The value of their homes has dropped. Credit via their homes or other sources has disappeared. The value of their market savings has deflated. With their confidence crushed, nobody knows how many rate cuts it will take to put the economy back on its feet.

The Fed funds rate is now 3.50%; the last time it went so low was in August 2005, when the US market indices were trading higher. Of course, rates can go as low as 1%, as witnessed in June 2003. The issue is not just rates but credit norms which have been tightened following the massive losses suffered by all top banks. Even if rates decline further, the ability of borrowers and the desire of the lenders will be a big issue.

The question is: if the largest economy in the world is tottering, how would that affect India? Everyone is only trying to guess the answer to this question because we have no history to guide us. India has not been so globally connected for many decades and technology and finance have never interlinked the world so closely. Our guess is that economically, India is deeply connected to the US and the rest of the world. We don’t believe in the decoupling theory.

The assumption behind the decoupling theory is that the world cannot do us in. We will run on our own steam. This is extraordinarily delusional. In our five years of prosperity, there has hardly been any step to reduce friction and costs of doing business. We have forgotten that the Indian political-bureaucratic nexus, especially at the state level, is too self-serving to create a model of sustainable economic growth, independent of the rest of the world. The decoupling theory assumes that we have an economic growth formula, when there is none. It downplays the extraordinary confluence of lucky factors that helped create this prosperity: globalisation (that tilts the balance of trade in favour of poor countries leading to massive transfer of wealth), low interest rates caused by a huge flow of portfolio money and the historical advantage of being an English-speaking country. None of these is our planned creation.

Financially, of course, we are coupled closely with the world. Indeed, that is the main cause for this market volatility. If the Sensex rose from 9,000 in four years (3,000 to 12,000) but leapt 7,000 points (13,000 to 20,000) in two months, it was entirely due to rate cuts in the US and a flood of speculative money flowing into India. And if the market collapsed by 30% in just a few days, that was also due to pervasive global gloom that affected us. Where is the decoupling in all this?


Canbank Venture Capital plans to launch new fund of Rs1,000 crore

Bengaluru-based Canbank Venture Capital Fund (CVCF) is planning a new fund of Rs1,000 crore in the next financial year.

Last month, Canara Bank promoted CVCF closed its fifth fund - a Rs500 crore "Emerging India Growth Fund" (EIGF). It has roped in 18 banks. Canara Bank was the anchor investor for this fund launched in June.

CVF will scale up its activity level in the future and the size of the next fund would be larger. It would be floated after completing investments from EIGF.

Banks are not forthcoming to commit large sums for venture funds due to stiff regulatory norms. Reserve Bank of India would consider such investment as exposure to the capital market, which is a sensitive sector attracting higher risk weights. Plans are also afoot to link capital market exposure to the capital adequacy of banks.

EIGF shall invest in diverse sectors with prime focus in the micro, small and medium enterprises (MSME) sector. Very small portion of the EIGF corpus would be set aside for start-ups. The average size of investment is targeted at Rs25-Rs50 crore and has the maturity of six years.  


Navam Capital invests $1 million in Vyome Biosciences

Kolkata-based early stage venture capital firm Navam Capital has invest $1 million in Vyome Biosciences Pvt Ltd, a new venture focused on dermatology and skin care.

Vyome will develop research-based pharmaceutical solutions for anti-fungal indications, chronic wound healing and for pigmentary disorders of the skin such as vitiligo.

The global dermatology and wound care market is estimated at over $15 billion.
Navam Capital is the early-stage investment arm of Kolkata based GPSK Investment, and focuses on early stage investments on advanced materials, life sciences, clean technology, Internet and other emerging technologies.


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