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The impact of repricing risk

The impact of repricing risk
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First Published: Tue, Jul 31 2007. 01 15 AM IST

Updated: Tue, Jul 31 2007. 01 15 AM IST
Reserve Bank of India governor Y.V. Reddy may well be one of the few people who might feel comforted if the global rise in risk aversion persists. That’s because it may lead to a deceleration in the spate of foreign inflows, thus relieving the central bank from having to choose between a stronger rupee and higher liquidity. When the governor presents his quarterly review of monetary policy on Tuesday, he will have an additional reason not to raise interest rates or hike the reserve ratio. It’s no accident that the BSE Bankex gained 1.7% on Monday, powered no doubt by the SBI results, but with most of the other banks chipping in as well.
These are early days, but the consensus currently is that a process of repricing risk is under way and the cost of debt will rise from its historical lows. At the same time, strong global growth will mean that demand for capital will remain strong. The net result is that accessing the international markets may not be as cheap as hitherto. The spread on the EMBI Bond index over US treasurys has risen sharply.
Of course, this is not the first time that spreads have gone up—they widened to even higher levels after last year’s stock market meltdown in May. But if we assume that this time the repricing of risk is going to last, it will result in higher borrowing costs for external commercial borrowings. Also, if the rupee loses ground, that too will add to the cost of borrowing in foreign currency.
Lower foreign inflows will also mean that the high levels of liquidity in the bond markets will get sucked out, as RBI no longer finds it necessary to buy dollars. The net result of a combination of substitution of foreign borrowing with local credit and lower liquidity could lead to higher interest rates locally as well. A weaker rupee could lead to higher oil and commodity prices. On the positive side, a weaker rupee could provide a much-needed boost to IT and other exporter stocks.
But all this is contingent on the perception that Indian assets are risky. It isn’t at all clear why that should be the case, with the economy forecast to grow at 9% this year. The recent Ascendas India Trust offering, issued in Singapore, was oversubscribed by 47 times and the books were closed a day early. With that kind of appetite for Indian paper, any repricing will probably be marginal.
HUL’s earnings surprise
Hindustan Unilever Ltd’s operating profit growth of 23.5% in the April-June period was its highest in the past five quarters. The markets lost no time in discounting that information - the HUL stock opened 4.6% higher on Monday and ended the trading session 6.7% higher at Rs 208.5.
It didn’t really matter that the surprise 126 basis points gain in operating margin came entirely on account of a cut in advertising and promotions spend. In fact, the company even said the drop in ad spend was partly owing to lower spend on a television channel due to pending negotiations. Analysts, too, aren’t pinning their hopes on further margin gains from cuts in ad spend. The shortfall last quarter will be made up in the next two quarters, they say, thanks to product launches, on the one hand, and higher ad rates, on the other.
The markets were, nevertheless, enthused by the strong double-digit profit growth, especially since growth was much lower at 9.5% and 3.8%, respectively, in the previous two quarters. Otherwise, there wasn’t much in the June quarter results to inspire confidence. Underlying volume growth was just 5.8%, and much of the 13.4% growth in domestic sales came from pricing improvement and a change in product mix. The soaps and detergents did better than analysts’ expectations, growing profit by 28.8% on the back of economies of scale and price increases. But that was offset by a negative surprise in the personal products business, which grew profit by just 9%.
Apart from the better than expected profit growth, what helped sentiment for the HUL stock is its first ever buyback worth Rs630 crore. The move would be EPS (earnings per share) neutral, as the reduction in the number of underlying shares would be offset by a fall in financial income due to the concurrent decrease in cash surplus.
Nonetheless, the buyback would result in a marginal increase in Unilever’s stake and is being seen as a sign of the parent company’s confidence of the Indian unit. Finally, HUL’s valuations have come down about 20% in the past year—its shares now trade at 24 times trailing valuations. The above two factors may ensure HUL shares wouldn’t revisit lows of around Rs170 they hit earlier this year.
Write to us at marktomarket@livemint.com
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First Published: Tue, Jul 31 2007. 01 15 AM IST