The index of industrial production (IIP) for April confirmed the trend thrown up by the purchasing managers’ index, which showed that while manufacturing growth has slowed, it seems to be holding stable around current levels. A three-month moving average of the year-on-year growth in the manufacturing index shows growth has been 6.7% for the months of February, March and April, slightly higher than the 6.4% for January, February and March.
The other interesting trend is the bounce in consumer durables. While the data has been volatile, the three-month moving averages show that growth in consumer durables is now marginally into positive territory, quite a change from the contraction seen around the middle of 2007. On the other hand, there are clear signs that the slowdown is now spreading to capital goods. It’s difficult to account for the bump in consumer durables, but Citigroup economist Rohini Malkani believes the budget tax breaks and wage hikes may have contributed to the recent buoyancy in the sector.
But the better-than-expe- cted IIP numbers are no reason to rejoice. That’s because the Reserve Bank of India’s (RBI) repo rate hike is a clear signal that the central bank wants to slow the economy down further. Any good news on the growth front is only likely to add to its determination.
The repo rate has been raised for the first time since March 2007, when manufacturing was growing at 16% and wholesale price inflation was at 6.7%. Gross domestic product (GDP) growth during January-March 2007 was at 9.7%. In the 14 months since March 2007, manufacturing growth has slowed to 7.5% while GDP growth in the January-March 2008 quarter too has slowed to 8.8%. Yet inflation based on wholesale price index has gone up more than 8%. Clearly, while RBI has been able to slow growth, it hasn’t been able to tame inflation. That’s because much of the inflationary pressure is driven by globally determined commodity prices, about which RBI can do little. At the same time, the repo rate hike seems to indicate that RBI believes that lowering demand is the only way it can have any effect on inflation.
Global oil giant BP Plc.’s recent Statistical Review of World Energy 2008, shows that while world oil production fell 0.2% in 2007, consumption rose 1.1%. A rise of 4.4% in consumption by emerging markets more than offset a fall of 0.9% in OECD (Organisation for Economic Co-operation and Development) oil consumption. What’s more; proved reserves of oil were slightly lower at the end of 2007 than at end-2006. These are the fundamental reasons for the rise in oil prices and speculators have only taken advantage of this.
In the circumstances, we’re likely to have the worst of both worlds—higher inflation and lower growth—for some time. For companies, already reeling from higher costs, RBI has signalled capital too will become more costly. That will affect consumption and investment demand. And, as the stock markets have learnt to their cost over the past months, it’s no use fighting the central bank.
Smart move by Grasim
Grasim Industries Ltd has made some smart exits from non-core and underperforming assets this year. It sold its majority stake in Shree Digvijay Cement Co. Ltd, seen as a dead investment till recently, for a handsome profit of Rs237 crore. This week, it said it has exited the sponge iron business for a consideration of Rs1,030 crore from Welspun Power and Steel Ltd. The business was valued at less than Rs300 crore by Merrill Lynch, according to a report dated 12 February. India Infoline’s institutional research team points out that the division has been valued at 6.4 times trailing Ebitda (earnings before interest, tax, depreciation and amortization), while the average analysts’ valuation was just three times Ebitda.
The sale is a positive development not only because of the premium valuation, but also because the division was adding little value to the company’s core business and was under pressure lately because of inadequate supply of natural gas. As a result, the division’s volumes fell 18% in the March quarter. While realizations were strong because of the surge in global scrap prices, they were offset by higher input costs. According to the company, however, the outlook should improve from next quarter thanks to increased availability of natural gas. This could be one of the reasons Welspun Power (an unlisted firm) has agreed to the high valuation.
Grasim’s sponge iron business posted revenues of Rs950 crore last fiscal year, accounting for 5.5% of consolidated revenues. The segment’s profit stood at Rs125.6 crore or less than 3% of the company’s consolidated profit before interest and tax. The consideration for the division amounts to about 5% of Grasim’s market capitalization and the funds will come in handy for its expansion plans in both the cement and viscose staple fibre (VSF) businesses.
While the sale of non-core/underperforming assets is a positive, both of the company’s core businesses have been under pressure lately. VSF has been hit because the slowdown in the US has resulted in lower demand for textiles. The division’s sales volumes fell by 10% last quarter. Cement, of course, has been affected by the government’s intervention in pricing and the outlook looks bleak because new capacities are expected to result in an excess supply situation in the near future. It’s not surprising, therefore, that Grasim’s shares have underperformed the market considerably this year. The stock’s fallen 42% from its highs in January, while the Nifty has corrected by 29%.
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