Stock market regulator Sebi has approved all of its original proposals on participatory note (PN) issuances, with the only comfort being that all PN issuing sub-accounts are in the process of being transitioned into FII (foreign institutional investors) accounts, and hence don’t have to unwind positions held on behalf of their PN holders.

But this was already made public after Sebi’s conference call with FIIs.

The incremental news after Sebi’s board meeting is that of further controls. The regulator has said that the issuance of PNs, within the 40% limit, would be only to entities that are regulated by securities markets regulators that are part of the International Organization of Securities Commissions.

Experts say that this will leave out a whole host of hedge funds which aren’t regulated. Earlier regulations allowed PNs issuances to unregulated entities, provided they were registered entities.

It’s highly unlikely such firms will be given direct registration—if they choose to be unregulated in their own jurisdiction, why would they want to be answerable to Sebi? This effectively closes the door for unregulated hedge funds, known to be a large source of funds for the Indian markets.

The Sebi chairman also reminded that PNs issued to unregulated entities would have to be would up in about 16 months (five years from March/April 2004). It’s still not clear what proportion of the Rs2.36 trillion worth PN holdings (with underlying stocks) are held by unregulated entities. But what’s important is that based on the proposals issued on October 16 and the clarifications issued later, the markets had factored in a sort of neutral impact on foreign inventor flows, with some short-term pain.

With unregulated entities (read many hedge funds) having to unwind cash market positions over the next 16 months or so, foreign inflows could be under further pressure than was earlier anticipated. As it is, all derivatives-based positions worth $30 billion (Rs1.19 trillion)would have to be unwound over the next 18 months.

Of course, one could argue that unwinding in the cash market by unregulated PN holders would free up the limit for FIIs to issue further notes. But then there may be a curb of fresh PN issuances, especially in the case where the FII account is close to the prescribed 40% limit.

Needless to say, the new information that’s come out after Sebi’s board meeting is negative in terms of the outlook on capital flows into the secondary markets (the primary markets are not likely to be hit much, given the high level of subscriptions even from regulated entities.) But the National Stock Exchange’s Nifty index is just 1.75% away from its level before Sebi’s proposals on participatory notes were issued, as if the impact is neutral. It does look like a correction is warranted.

Ashok Leyland

Ashok Leyland Ltd’s shares haven’t budged from the Rs36 levels since the company announced decent September quarter results. Operating profit rose 24% year-on-year last quarter despite a 4% decline in volumes. In the June quarter, too, profit had risen by 27.5% although volumes had grown in just single-digits.

The lacklustre performance of the company’s shares suggests that much of pain of slowing commercial vehicle sales is still to be reflected in the company’s financials.

Profit growth in the last two quarter’s was primarily on account of a favourable product mix. While commercial vehicle sales have been declining, sales in the passenger bus segment have been robust. Incidentally, this segment enjoys higher profit margins.

Although the absolute profit on a per vehicle basis is lower than those the company enjoys with its medium and heavy commercial vehicles, it’s higher as a percentage of sales. Besides, sales of spare parts have grown substantially on a year-on-year, and so have sales to the armed forces. These segments also enjoy higher margins.

In the first six months of this fiscal, operating profit, even after adjusting for gains on account of forex fluctuation, has grow by 25.7%. But the growth in profit before tax and non-operating income was just 12% because of a sharp increase in interest costs—from Rs0.9 crore in the year-ago period to Rs25.4 crore in the first six months of this fiscal. Some of the increase in interest burden was on account of borrowings for expansion, but some was on account of higher working capital requirements.

Analysts point out that both inventory and receivables have increased considerably this fiscal. While this impacts working capital needs on the one hand, the other more serious issue is that some pain can be expected in future quarters as the high inventory position is corrected.

Some analysts have reduced their volume growth estimates for the company owing to the high inventory both with the company and with dealers. This means that the 12% growth in core profit in the first six months isn’t an indication of growth for the rest of the year. Keeping that in mind, and coupled with the low investor sentiment for commercial vehicle manufacturers, the company’s valuation of over 12 times estimated FY08 earnings leaves little room for an upside.

Write to us at