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Capital goods run out of steam

Capital goods run out of steam
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First Published: Mon, May 12 2008. 11 48 PM IST

Updated: Mon, May 12 2008. 11 48 PM IST
Indian stock markets shrugged off the dismal Index of Industrial Production or IIP data on Monday, preferring instead to take heart from rising European indices. Another reason was the sliding rupee, which boosted IT stocks. But the explanation also lay in the swift response by economists that the effect of a high base in March 2007 had a lot to do with the low numbers for March.
Manufacturing growth was as high as 16% in March 2007, much higher than the growth in February that year. But was that enough to send such growth reeling in March this year to a six-year low of 2.9%?
The worst performer was consumer durables, down 2.1% in March from a year ago. The slowing in this sector is a result of rising interest rates and there’s not much of a base effect. It is probably why the auto and realty indices at the Bombay Stock Exchange, or BSE, ended in the red on Monday.
The surprise lay in consumer non-durables, up a mere 0.6% compared with March 2007. This was rather unexpected, and corporate numbers for the March quarter seem to contradict such a slowdown, with most fast moving consumer goods, or FMCG firms showing not just volume growth but also the ability to pass on price increases.
Sure enough, there’s a huge base effect at work here; in March last year, this sector saw a growth of 20.2%. The BSE’s FMCG index was up over 1% on Monday, which indicates that the market took the consumer non-durables numbers with a pinch of salt.
The problem, however, lies with capital goods. The index for this segment was at 8.6%, well below February’s 10.4%. While growth in capital goods was a high 18.1% in March last year, the decline is clear if we look at a three-month moving average of growth in capital goods.
Declining growth in capital goods must be added to the difficulties engineering and capital goods companies are facing. Rising input prices, unavailable components as well as problems with contractors add to the reasons for the underperformance. Given these circumstances, it’s doubtful if the BSE capital goods index deserves the premium valuations it still commands.
Indeed, that may well hold true for the market as a whole. With slowing growth, high inflation and political uncertainty, combined with valuations at a premium to the region, the India story is rapidly running out of plots to keep investor interest alive.
Asian Paints: good performance but limited upside
Mumbai-based Asian Paints Ltd is one of those rare stocks that hit a 52-week high in recent times. While the S&P CNX Nifty index on the National Stock Exchange has lost about 18% in value this year, Asian Paints’ shares have gained more than 9%.
The stock has outperformed the index, though, not without good reason. It is in a sweet spot—volume growth has been steady, raw material costs have been stable and it has even managed to increase prices marginally during the year. The upshot: a 20% increase in consolidated revenues and a robust 37.7% growth in operating profit for the year that ended on 31 March.
Its operating margin rose by nearly 200 basis points to 15% as prices of all of the company’s raw materials, except crude oil, have been benign. What’s more, with an increasing share of the company’s revenues coming from emulsions (that use water as a base and do not so much depend on crude), raw material costs fell by 140 basis points as a percentage of sales. The company also gained from a rising rupee, since it imports a large part of its raw materials.
A basis point is one hundredth of a percentage point
The financials of the recently concluded March quarter indicate that its performance continues to be good. Operating profit grew 33% on the back of a 18% rise in sales and a 155 basis point improvement in profit.
Analysts say that the company should continue growing revenues at a healthy pace of about 20%. Earnings growth, however, may now trail the rise in sales, as some of the factors that aided margin growth last fiscal may not continue. The rupee, for instance, has depreciated sharply in the past week, and this would impact raw material costs. And, although the influence of crude is relatively less, the jump in crude oil prices lately is worrying.
Meanwhile, the stock has rallied strongly since last year and now trades at nearly 28 times of its past consolidated earnings. According to Bloomberg, most analysts have a buy rating on the company. Still, there’s little upside possible based on the price targets set by some analysts. The average price target of all analysts polled represents a mere 10% upside.
Write to us atmarktomarket@livemint.com
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First Published: Mon, May 12 2008. 11 48 PM IST