Cipla Ltd reported a surprise 23.4% increase in operating profit for the December quarter, on the back of a 15.7% drop in profit in the first six months of the fiscal. Much of this has to do with a trebling in the company’s income from fees related to technology know-how.
This income can be lumpy and difficult to predict, and was the sole reason analysts’ consensus estimates were trumped. Last quarter, technology-related fees accounted for 28.5% of operating profit—up from 12.1% in the year-ago December quarter, and 13.7% in the first half of the current fiscal.
Even the rest of the business did relatively better than the performance in the first two quarters of this fiscal. Adjusted for the technology fees, operating income was flat last quarter—much better than the 22.8% drop in profit in the first-half period. According to analysts, this is partly because of the low base in the year-ago October-December period.
In any case, margins have continued to decline owing to the rupee appreciation. Last quarter, operating margin fell by 350 basis points after excluding technology fees. But an analyst with a foreign brokerage tracking the sector insists that the high technology fees was the only surprise in last quarter’s results.
While the company claims that the jump in technology fees is not one-time in nature, not all analysts are expected to revise earnings estimates, given the unpredictable nature of the fees. As things stand, Cipla’s earnings are estimated to grow by about 15% in the near-term, but it trades at a valuation of more than 20 times fiscal 2008 earnings. One factor that works in the company’s favour though is that it gets a larger proportion of revenues (50%) from the domestic market. Since concerns of an appreciating rupee remain, Cipla may be seen as a better bet for an exposure to the sector.
The dollar smile
Despite the spate of selling by foreign institutional investors (FIIs) in the secondary markets since December, the rupee has remained remarkably stable against the dollar. This could be because of the large inflows to the initial public offerings on the one hand and non-FII inflows such as remittances on the other.
Some banks are slowly turning around to the view that the worst may be over for the dollar. According to the “dollar smile” theory, of which Morgan Stanley’s Stephen Jen has been a big supporter, the dollar actually strengthens during a US recession, as investors rush to the safety of US bonds. In 2001, for instance, the last time during which the US was in a recession, the dollar rallied against the euro and against the British pound. The “smile” theory says that the dollar appreciates both when there’s a US recession and high American growth, situations that represent the two upwardly curved ends of the “smile”. It’s only in the middle of the cycle—when the US is weakening, but the rest of the world is fine—that the dollar sags.
At present, the argument is that while the US Fed has already started reducing interest rates, other central banks will follow suit as the US recession starts affecting their economies. That would mean that these currencies have reached their tops against the dollar. The market has already started discounting interest rate cuts by the European Central Bank and the dollar has been steady against the euro, despite the recent US rate cut. At the moment, however, a stronger dollar is still a contrarian call.
To couple or decouple, that is the question. While the mayhem in emerging markets has given credence to the theory that their markets have the power to chart their own course, China’s fourth quarter (Q4) results indicate a high degree of resilience to the US slowdown. China’s gross domestic product rose by 11.2% year-on-year in Q4 of 2007, despite all the interest rate hikes and the increases in the reserve ratios. True, it’s lower than the 11.5% growth in Q3 (third quarter), but this is hardly a slowdown. And this growth has occurred when some analysts believe that the US had already slipped into a recession—Deutsche Bank AG has forecast 0% growth in the US in Q4.
And finally, another recent vote of confidence in emerging markets has come from Merrill Lynch and Co. Inc., which is increasing its staff strength in these regions, while slashing it in the developed world.
While the majority of market participants panicked in the market crash earlier this week, a set of smart traders have been busy making money, and that too without taking an ounce of risk. That’s simply because of the vast number of arbitrage opportunities between the cash and derivatives segments of the equity market. Derivatives analysts point out how a forced or coerced unwinding of futures positions on Monday and Tuesday led to sharp discounts in futures prices. For an investor who held such stocks, the simple thing to do would be to sell them and buy the same quantity cheaper in the futures segment. The difference was risk-free profit.
No single investor group probably did it better than FIIs. According to data published by the Bombay Stock Exchange, they sold shares worth Rs10,584 crore in the cash segment between Monday and Wednesday. A large part of this seems to be arbitrage transactions, as FIIs also bought shares worth Rs9,434 crore in the futures segment.
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