One of the distinguishing features of a bear market is that it ignores all good news. By that criterion, the market’s reaction to the Fed rate cuts indicates that we’re probably in a global bear market. The US market on Wednesday closed lower than where it was 10 days earlier, despite the rate cuts by the US Fed and the announcement of a fiscal stimulus package by the government. With Standard and Poor’s downgrading or putting on negative watch half a trillion dollars worth of mortgage-backed debt, it’s clear that the worst is far from over in the credit markets. As S&P points out, bank losses may now mount to $265 billion (Rs10.44 trillion) —they’ve written down only around $70 billion so far. That should crimp liquidity even further, offsetting the impact of the Fed rate cuts.
Apart from the health of the financial sector, some economists believe that the Fed may be pushing on a string. That’s a reference to the concern that although the central bank may reduce interest rates, banks could refuse to lend and borrowers, with incomes reduced by the slowdown, may prefer not to borrow. Taken together with the dismal GDP growth in the US for the last quarter of 2007 (although part of that is due to inventory de-stocking), the uncertainties in the market are extremely high. As a matter of fact, the Fed rate cuts have played a major part in keeping the US Dow Jones Industrial Average at around the same level as the lows of last August.
For the Indian market, the Sensex is still around 28% higher than the depths it plumbed last August. As explained in this column before, the earnings of half the Sensex companies are dependent on global factors.
A similar study for the BSE 500 carried out by us shows that the earnings of 46% of the BSE 500 companies are also connected to what happens in the global economy. And the half of the market that’s relatively insulated from global trends is richly valued. What’s more, corporate results for the December quarter show that profits growth continues to decelerate. True, on a price-earnings growth basis, many Indian stocks continue to be attractive. But till the credit crisis eases, it’s likely that money will continue to flee into US bonds and money market funds.
RCom vs Bharti
Reliance Communications Ltd’s premium over Bharti Airtel Ltd has come crashing down. The stock has corrected by 29% from its highs in early January, while Bharti shares fell by just 15%. Now, the company’s enterprise valuation is about 17 times trailing Ebitda (earnings before interest, tax, depreciation and amortization), compared with 16 times in the case for Bharti. The company’s results for the December quarter provide no reason why it should trade at a premium.
Revenue and profit growth rates are much lower than Bharti’s. In the core wireless business, which accounts for three-fourths of Reliance’s profit, revenue grew by 6.3% sequentially (compared with the September quarter), while growth for Bharti was around 11%. Reliance’s revenues, like its competitors’, are getting hit by the expansion into rural areas and low-income users. Unlike its competitors in the GSM space, it maintained the average rate it realizes on every minute of call, but average minutes of usage fell more than 8%. As a result, average revenue per user (Arpu) fell sharply by 6% to Rs339. The company has cut rates for its pre-paid customers this month, which could again lead to a drop in Arpu this quarter.
The company is set to launch nationwide wireless services on the GSM platform, but the growth will come at a cost. An analyst with a foreign brokerage says the capital expenditure of $6 billion estimated by the company for fiscal 2009 is higher than his estimates. Investor interest in the future will depend largely on the success of the company’s GSM rollout and government policy on spectrum issuance.
Tata Chemicals Ltd’s purchase of General Chemical Industrial Products Inc. (GCIP), a US-based natural soda ash manufacturer, appears to be a good buy, going by the limited information the company has provided. It has paid Rs3,940 crore for GCIP’s 2.54 million tonnes (mt) capacity, or about Rs1,551 crore for every million tonnes of manufacturing capacity. In addition, GCIP has large reserves of extractable trona ore from its current mines, and has the requisite associated infrastructure for distribution. Analysts point out that about a decade ago, Nirma Ltd had set up a greenfield synthetic soda ash manufacturing capacity of 0.42mt at a cost of about Rs800 crore, or Rs1,900 crore per mt of manufacturing capacity.
This doesn’t necessarily mean that the acquisition has come cheap, but it does indicate that putting up a greenfield soda ash manufacturing unit has become nearly unviable. Whether the acquisition price is reasonable or not depends on the financials of GCIP, details of which are not known. Nirma’s recent acquisition of US-based Searles Valley Minerals was in the same space, but unfortunately the company didn’t share the acquisition cost. Soda ash prices have risen sharply in the past year, but again that doesn’t necessarily mean the payback period will be short, as it also depends on GCIP’s cost structure. The fact that Tata Chemicals’ shares fell about 7% suggests that the markets are worried about the increase in leverage at the company. The company’s shares have now fallen nearly 30% from its 52-week high, and if one were to consider the embedded value of the various Tata group companies’ stake Tata Chemicals holds, the core business looks cheap.
Ashwin Ramarathinam contributed to this story.
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