What comes through from the Reserve Bank of India’s third quarter review of monetary policy statement is that on one hand governor Y.V. Reddy is still very worried about inflationary pressures in the economy, on account of rising money supply and high food and fuel prices.
On the other, he’s not particularly bothered about the slowdown in growth. The crux of the policy statement is this: “While the dangers of global recession are relatively subdued at the current juncture and consensus expectations seem to support a soft landing, the upside pressures on inflation have become more potent and real than before. Food and energy prices are set to impart a permanent upward shock to inflation globally and, in particular, in emerging market economies.” That’s the reason the apex bank has chosen perhaps to err on the side of caution, preferring to wait and watch.
What does that mean for the markets? The immediate reaction was a sell-off in the interest-rate sensitive stocks and in the bond markets, which had hoped for a rate cut. However, bond prices are likely to continue to be supported by cuts in the Fed funds rate on the one hand and bad news on the global economy, which is likely to increase the chances of the apex bank lowering rates in future on the other. The rupee will also continue to see upward pressure—the past few weeks have shown that the rupee has remained strong in spite of outflows from the stock markets.
Bank stocks should continue to do well, for several reasons. One, expectations of a rate cut in future will help buoy them. Two, they will benefit from lending to the booming capital goods and infrastructure sectors. And three, many public sector bank stocks are valued very reasonably.
The outlook may be different in the other rate–sensitive sectors, however. The absence of lower rates means that consumption growth is unlikely to pick up, although higher agricultural growth could help. Unlike banks, these sectors take longer to benefit from a rate cut. Even if banks lower their lending rates in April without waiting for the apex bank to change its policy rate, it’ll take some time for the results to start showing up in auto companies’ profit and loss. The real estate sector has even more problems, given the earlier big rally in both home prices and the prices of these stocks.
Shares of Maruti Suzuki India Ltd rallied about 6% from an intra-day low of Rs816.3 after the company reported better-than-expected results for the December quarter. The company reported a pre-tax profit of Rs683 crore—higher than the consensus estimate of Rs668 crore of analysts polled by Bloomberg. But the results lose some of its lustre after adjusting for a foreign exchange-related gain of Rs23 crore. Adjusted for this, pre-tax profit has grown a mere 2% compared with the preceding September quarter. Note that the October-December period is traditionally a more lucrative period for auto makers because of major festivals. The fact that profit grew just 2% sequentially reflects the severe price competition it faced during the festive period. Average realizations fell 2.5% sequentially and operating profit per vehicle sold has declined by 2.7%.
Having corrected about 30% from its 52-week high, Maruti now trades at just 13 times trailing earnings, which appears very cheap considering core earnings have grown by 24% in the first nine months of this fiscal year. But note that if the price competition seen last quarter were to continue, earnings growth would take a hit in the near future. After all, this year’s growth has been aided by a 8.6% increase in average realizations. In addition, the proportion of royalty is higher of new cars launched by Suzuki’s Indian subsidiary. Notwithstanding these concerns, a majority of analysts continue to be positive on the stock, with the average target price put out by Bloomberg suggesting a 20% upside.
Jet Airways (India) Ltd’s pre-tax loss stood at Rs 221.6 crore in the December quarter after adjusting for non-operating revenues. The only times losses have been bigger were in July-September 2007 and July-September 2006. Unlike the lean monsoon season, when yields are the lowest, this time around the high loss has come about during the peak season, where yields have been traditionally high owing to the holiday season. The company continues to suffer due to high-than-required capacity addition in the domestic market. Costs have increased 10.5% year-on-year, but average yields have improved by about 7% for the domestic operations, resulting in losses at the pre-tax level. The international business, however, has a larger role to play in the record losses, reporting a pre-tax loss of Rs117 crore. Here, costs rose by 7.7% and yields fell by 4%, thanks mainly to a large capacity addition. International revenues rose 120% on the back of new route additions, which normally take 12-18 months to break even.
Apart from this, Jet is burdened by debt worth Rs10,191 crore, which is 4.8 times its net worth. Last quarter, interest cost rose by 139% to Rs 155 crore—marginally higher than the operating profit of Rs154 crore. An interest cover of less than one and a debt-equity of about five times would normally cause panic among investors. But Jet has some factors working for it. Nearly 80% of its debt is linked to the London interbank offered rate (Libor) and is denominated in foreign currency. While the rupee is expected to continue appreciating, the three-month Libor has dropped from 5% just three months ago to 3.25% now. What’s more, Jet has doubled its equity fund raising target to $800 million (Rs3,152 crore), including a private placement, which should ease the debt burden.
On the operations front, the management gladly noted in a call with analysts that capacity addition in the domestic market had fallen to 22% last quarter, from 35-40% previously. If the trend continues, yields will inch up further, after the price hikes following the consolidation moves in the industry last year. Given these factors, Jet’s financial performance may well be close to a nadir.
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