Rally in rate-sensitive segments likely to fade

Rally in rate-sensitive segments likely to fade
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First Published: Mon, Jul 28 2008. 11 37 PM IST

Updated: Mon, Jul 28 2008. 11 37 PM IST
Bonds as well as stocks sensitive to interest rates have run up quite a bit on the eve of the Reserve Bank of India’s, or RBI’s, quarterly monetary policy review on Tuesday. The yield on the benchmark one-year government security has fallen from around 9.5% on 10 July to its current level of around 9.1%.
The Bombay Stock Exchange’s Bankex index is up 25% from its close on 16 July, well above the 14% rise in the exchange’s bellwether Sensex index. The BSE Realty Index is up 20% over the same interval.
The rise in rate-sensitive stocks and bond prices has been in the hope that lower international crude oil prices will ease the pressure on inflation, or, at the very least, reduce the amount of oil bonds to be issued, and therefore, improve the fiscal situation. Also, the rise in bank stocks is partly on account of all the talk of reforms in the sector.
But the expectation of lower oil prices leading to lower inflation is misplaced, because Indian fuel prices are, in any case, well below international prices. RBI can hardly afford to use lower oil prices as an excuse to pause in its fight against inflation.
Indeed, the central bank expects international oil prices to remain at elevated levels “in view of the relatively tight demand-supply balance”. Moreover, credit growth remains strong. RBI data show that on 23 May, the year-on-year rise in non-food gross bank credit has been Rs4,22,418 crore, or 24.1%. The speculation was that credit to the cash-strapped oil sector was largely responsible for the rise.
But, data now show that credit to the petroleum, coal products and nuclear fuels sectors rose by Rs18,250 crore in the year to 23 May, compared with Rs9,884 crore in the year to 25 May 2007.
Even if the growth in credit in this sector had been the same as last year—an unreasonable assumption—all that would happen is that year-on-year non-food credit growth would have been 23.6%, which is certainly not low. Growth in the services sector is at an annual rate of 31.3%. Under these circumstances, RBI can hardly afford to press the pause button. However, if it hikes its policy rate, a negative reaction is likely, given the climb in stocks and bonds.
L&T’s June quarter: no let-down in growth
Results of engineering firm Larsen and Toubro Ltd, or L&T, for the quarter to June show no signs of a slowdown. Revenues grew by 53% year-on-year, operating margin was maintained and order inflow of the engineering and construction business grew 28% year-on-year and 7.2% over the March quarter.
(NARROWING GAP) The Mumbai-based company’s mainstay engineering and construction business has an order backlog of Rs56,336 crore, 10.6% higher than at the end of the March quarter. The order backlog is 2.6 times its 12-month past revenues, providing reasonable visibility for future growth.
A large portion of the company’s orders come from the oil and gas sectors, which is unlikely to see a slowdown in capital expenditure soon, given that oil prices continue to remain high. The company says it’s too early to say if order booking would slow in the near future. The company has also maintained the guidance given earlier this year that order inflow would grow by about 30% this year.
One concern investors have is whether the company would be able to maintain margins, given the inflationary pressure on material costs.
Last quarter, raw material costs jumped by 244 basis points as a percentage of operating revenues. But thanks to the sharp jump in revenues, fixed costs such as administrative costs and staff expenses fell as a percentage of revenues. The net result was a slight 15 basis point improvement in margins.
Hundred basis points equal one percentage point.
Being a net exporter, L&T was also helped last quarter by the depreciation in the rupee.
About 60-70% of the company’s order backlog is now in contracts that have some sort of protection against inflation in the form of cost-escalation clauses, cost-plus arrangements, or agreements where the customer provides the materials. About two-and-a-half years ago, the reverse was true, and 60-70% of the projects were prone to inflationary pressures. This would further help the company protect margins in the future.
Although operating margin was maintained in the June quarter, depreciation charges and interest costs swelled, thanks to expansion. As a result, profit before tax rose just 31%.
After having corrected by about 50% from its highs in January till early this month, L&T’s stock has recovered about a fourth of those losses.
Adjusted for the market’s toned-down estimates of the valuation of the company’s subsidiaries (about Rs350 per share), the core business trades at 30 times past earnings per share. That’s almost in line with the rate at which earnings are growing. There seems little room for upside.
HDFC Bank maintains strong growth
Private sector lender HDFC Bank Ltd’s results for the June quarter are not comparable with those a year ago, because the bank’s merger with Centurion Bank of Punjab Ltd, or CBoP, became effective from 23 May this year, and hence, the results include the impact of the merger.
It’s obvious, therefore, that growth will show a higher-than-usual rise. However, Paresh Sukthankar, executive director at HDFC Bank, said that on a like-to-like basis, the lender’s stand-alone numbers have shown a growth comparable with that in previous quarters. He said that after adjusting for CBoP’s extraordinary income in the year-ago quarter, the combined CBoP and HDFC Bank net profit has improved by about 34% year-on-year.
What’s interesting is how the merger has affected some of the bank’s important parameters. For instance, net interest margin has declined from 4.4% in the March quarter to 4.1% in the June quarter. That’s because the proportion of low-cost current and savings accounts, or CASA, has reduced from 54.5% of total deposits to a much lower 44.9% of total deposits, since CBoP’s CASA ratio was far below that of HDFC Bank.
Asset quality, too, has shown a deterioration with gross non-performing assets, or NPAs, going up by Rs596 crore to 1.5% of net customer assets, compared with 1.3% at the end of the March quarter. Net NPAs were more or less the same, at 0.5% compared with 0.4% at March-end. In absolute terms, however, the increase in bad loans has been substantial, with both gross and net NPAs rising 65% from the March quarter. But, Sukthankar says that except for an increase of about Rs80 crore or so, the rest of the rise in NPAs is due to bad loans at CBoP.
Among other key ratios, the fee income to operating income has actually improved, from 25% in the March quarter to 29%. Operating costs, however, increased as a percentage of operating income from 50.3% in the March quarter to 55.6%—the impact of CBoP’s higher costs is clearly being felt.
The bank’s loan to deposit ratio has also increased substantially, from 62.9% at the end of March to 73.9% at the end of June. Perhaps most importantly, the average return on assets for the June quarter was maintained at 0.3%, the same as in the previous quarter.
Some short-term pain as a result of the merger was widely expected, but the June quarter results have been better than anticipated, thanks mainly to lower-than-expected provisions. The bank’s management said its mark-to-market provisions on account of depreciation in the value of government securities was lower because of a higher proportion of “held to maturity” securities and their lower duration.
As the integration with CBoP progresses, the bank should be able to leverage the latter’s network to add business, get more low-cost deposits and further improve its performance.
Write to us at marktomarket@livemint.com
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First Published: Mon, Jul 28 2008. 11 37 PM IST