After the worse-than-expected December quarter results at Bharat Heavy Electricals Ltd(Bhel), there was a lingering hope that the debacle was due to one-off factors, such as the provision made for a wage hike, or a slightly slower pace of execution during that quarter. The company’s provisional numbers for the March quarter dispel that illusion.
Net profit during the quarter has fallen by 7.4% to Rs1,065 crore rupees. Although the detailed break-up of the results will be available only later, the company management has blamed wage provisions once again, apart from higher raw material costs.
Capital goods stocks had been the stars of the boom, with good reason. Huge investments are being made in infrastructure, especially in the power sector and scarcely a month passes without the announcement of a new order being secured. Even today, Bhel’s order book continues to bulge and the order backlog is now Rs85,500 crore against Rs78,000 crore at the end of the December quarter.
The problem is those orders aren’t getting translated into profit. The management says the growth in turnover has been just 8% in the last quarter. The last two quarters have proved that growth in the order book, seen by analysts as a guarantee of “earnings visibility”, may be a necessary but not a sufficient condition for higher profit.
As a matter of fact, Bhel seems to be having an uphill struggle executing its orders. Add to that wage pressures not only on account of pay revisions but also because of a bigger workforce, rise in raw material cost, the costs associated with its large capital expenditure plans and low margins on orders for supercritical units and it seems increasingly likely that the days of Bhel’s high margins are behind it.
In this environment, the key to profit lies in higher turnover, which is where speed of execution becomes important.
With its fiscal 2008 earnings per share at Rs57.5, Bhel is currently trading at a price of around 28 times trailing earnings. That seems too high for a company whose net profit rose by just 17% last year.
But perhaps the bigger concern from Bhel’s results is whether, despite robust investment demand in the economy, the net profits of companies in the capital goods sectors may not capture that growth. The 40% drop in the BSE Capital Goods index from the peak it reached last November suggests that the market is fully aware of that concern.
Deciphering the protest by jobbers and arbitrageurs
Jobbers and arbitrageurs are protesting the change in the tax treatment of the securities transaction tax (STT) with their feet. This set of traders have stayed away from the markets since 1 April, the day from which the new tax rules are applicable. The STT paid by traders will no longer be offset against their total tax liability, but would be treated as a deduction from taxable income. The move will lead to an increase in tax incidence for all traders.
How has the protest affected traded volumes? The National Stock Exchange’s cash market turnover has reduced by about 19% in the first four trading sessions this month compared with the last few sessions in March. Derivatives turnover has been hit more, falling by 28%, with stock futures facing most of the brunt (down 37%). The Bombay Stock Exchange’s cash market turnover has fallen about 21%, in line with that of NSE. But turnover on Sensex futures, one of the few derivatives contracts that trade on the exchange, fell by about 80% to Rs200 crore. While that gives a sense of where jobbers were most active, the larger point is that turnover has fallen across segments (except options, which don’t seem to be popular with this set of traders). Note that the broker community had managed to get the finance minister to cut back the STT rate significantly after it was first proposed, through asimilar protest.
For most stocks on which futures trading is available, turnover in the cash segment is higher—this defeats the purpose for which stock futures were introduced in the first place. Of course, there are other reasons, such as the unwillingness of brokers to let clients take leveraged positions, after the painful experience between January and March. But the STT related protest is making things worse.
The high powered expert committee on making Mumbai an international finance centre had called for the abolition of STT, which it refers to as a ‘bad tax’ and one that leads to high taxation and hence inefficiency. What the STT does—the changed tax treatment only aggravates things—is that it deters traders from executing strategies that involve thin spreads, leading to lower liquidity. True, no one complained about STT when the markets were doing well and turnover hit all-time highs. But then, in a world without STT, liquidity would have been even higher.
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