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Sensex has already decoupled

Sensex has already decoupled
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First Published: Sun, Jan 27 2008. 10 58 PM IST
Updated: Sun, Jan 27 2008. 10 58 PM IST
This week is going to be critical for the markets, with both the Reserve Bank of India and the US Federal Reserve taking decisions on interest rates. The Indian bond markets are pricing in a 25 basis points rate cut, while the Fed funds futures traders feel there’s a 76% chance of a 50 basis points cut on 30 January.
It’s worth noting that the Dow Jones Industrial Average is now 2% lower than the depths it plumbed last August, when the first news of the credit crisis sent stocks plummeting. Since then, the US market hasn’t improved, even though the Fed funds rate has been cut by 175 basis points, banks have been recapitalized and a fiscal stimulus is in the offing. There’s no reason, accordingly, for equities to take off just because the Fed cuts rates by another 50 basis points this week.
The Indian market is in a very different situation, with the Sensex up 33% from the lows of August. The Sensex price-earnings multiple is now 23, compared with 19 at its lowest last August. As far as the Sensex is concerned, decoupling has already occurred.
Dr Reddy’s Lab
Drug manufacturer Dr Reddy’s Laboratories Ltd ADRs (American depository receipts) fell 6% on higher-than-average volumes after the company reported a loss for the quarter ended December. Regardless of how the Indian markets open on Monday, Dr Reddy’s shares should correct to reflect the worsening fundamentals of the company.
Its German acquisition, Betapharm Arzneimittel GmbH, is increasingly becoming a drag on profit. Last quarter, the company even took a write-down of certain intangible assets related to Betapharm. But a write-down was expected at some point—product prices in Germany had fallen sharply and hence, return expectations from the acquisition had whittled down considerably.
What’s more worrying is that there’s no sign of improvement. Analysts had been hoping that a shift in production to Indian facilities would lower cost of production and hence, salvage the situation to some extent in Germany. But net realizations from the German market continue to be under threat as the influence of insurance companies has grown and they are ensuring large rebates from pharmaceutical companies such as Dr Reddy’s.
According to the company, the rebates are one of the reasons for the write-down in its investment in Germany. So, even if the shift in manufacturing would help cut costs, the heavy price discounts/rebates will continue to erode profitability.
One might argue that Betapharm accounts for only 17% of total revenues and so has a limited impact on the company’s financials, but note that Dr Reddy’s had taken a large bet by investing as much as $570 million (Rs2,245.8 crore) in Betapharm. The write-down of $60 million amounts to about 10% of the original investment.
Price competition continues to be severe in the generics space—the prices of some key products in North America fell last quarter. Coupled with this, the recently acquired custom pharmaceutical services business in Mexico, which has lower-than-company margins, caused a sequential drop in the company’s gross margins.
Yet, some segments are doing well—the active pharmaceutical ingredients business has grown 18% year-on-year in dollar terms and continues to enjoy healthy margins of about 32%. On a year-on-year basis, the generics business has improved margins substantially, and the organic custom pharmaceutical services segment has grown by 24%.
Having said that, the market is likely to be focused on the generics market in Europe and, in particular, Germany, as it could drag down overall performance. Although the stock is relatively cheap—it has underperformed the Nifty by 76% since April 2003 and now trades at 15 times fiscal 2008 earnings (excluding write-down)—it would continue to underperform unless there are triggers such as new product launches with exclusivity rights.
Voltas overview
Voltas Ltd’s profits before tax and exceptional income rose 94% in the December quarter on the back of a 16.8% increase in net sales. That’s because operating margins shot up to 7.8%, compared with 4.3% in the year-ago period.
Add higher “other income” and lower interest costs and you get the huge rise in profit before tax. Voltas also has an order book of about Rs3,500 crore —Rs2,700 crore in the international market and Rs760 crore for domestic projects. The execution of some international orders was delayed through no fault of the company and it’s likely that they will add to revenue growth in the next quarter.
On a year-on-year basis, margins have improved in the company’s dominant electromechanical projects segment, going up from 5.1% to 7.4%. In the unitary cooling products business, margins were 5.2%, compared with a loss in the year-ago period, as a result of a shifting of its manufacturing operations from Hyderabad to Himachal Pradesh, where it enjoys excise benefits. But margins were squeezed to 17.7% in the engineering products segment, down from 21.4%.
Revenue growth was affected by a slowdown in machine tools and material handling because of adverse conditions for the auto and ancillary businesses. Margins fell because engineering products earlier used to be a commission business, with no material costs, while it has now become a manufacturing business.
The company has made no change in its guidance of Rs10,000 crore turnover by fiscal 2011. In the nine months to December, revenues were Rs2,232 crore. Net profit margin, forecast to be 10% by fiscal 2011, was 6% in the first nine months of the current fiscal year. At around Rs210, the stock trades at about 24 times fiscal 2009 earnings, which isn’t cheap. But cash generation is more than operating profit and revenue visibility is very strong.
Write to us at ­marktomarket@livemint.com
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First Published: Sun, Jan 27 2008. 10 58 PM IST
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