The rally in Indian stocks since the US Federal Reserve cut rates is largely restricted to large-cap stocks. Even in the mid-cap space, it’s stocks with a market value of over Rs5,000 crore that have found favour. One reason for this is that much of inflows have come from foreign institutional investors (FIIs). They made investments worth Rs4,100 in the cash segment on Wednesday and Thursday, besides taking long positions worth Rs3,600 crore in the futures market.

Another factor, as the adjoining chart illustrates, is that large-caps had underperformed prior to the rate cut. Since the market peaked on 24 July and until the Fed rate cut, stocks with a market cap exceeding Rs25,000 crore fell marginally, while those in the lowest strata (market cap of less than Rs100 crore) rose almost 18%. The degree of increase in valuation during this period was directly proportional to the market cap. The lower the market cap, the higher the increase.

This relationship has reversed in the past three trading sessions with FIIs returning to dominate the markets. While stocks with market cap exceeding Rs25,000 crore have risen 7.1%, those with less than Rs100 crore market cap have fallen marginally.

But large caps still have a lot of catching up to do, given the high degree of underperformance since July. Even after accounting for the recent jump in prices, they continue to underperform their small-cap counterparts by about 9%. If anything, uncertainties about the global economy should have increased the premium for large-sized, established companies. But because of the absence of FIIs for much of the past two months, the reverse has happened. It’s time the anomaly corrected. One way would be for large-caps to rise further, but given that valuations are already high for most of these stocks, the better way would be for small-caps to correct.

Suzlon Energy

Among the top five losers in the BSE 100 on Friday was Suzlon Energy Ltd. While the index rose 1.4%, Suzlon shares declined 2.4%, after it announced that it raised $200 million through an FCCB (foreign currency convertible bond) issue. The pricing of the issue was relatively unfavourable compared to the company’s previous issue in May.

The conversion price of Rs1,859.4 represents a premium of 30% to the five-day volume weighted average share price until 20 September, the day before the convertible’s pricing was fixed. The company’s $300 million FCCB issue four months ago had a conversion premium of about 60%.

The yield till maturity is set at 7.55%, almost in line with that of the company’s previous issue (7.6%). Jaiprakash Associates Ltd recently issued an FCCB of $400 million, also at a high yield till maturity of 7.95%. Its conversion price, however, was set higher at 45% over the reference share price. Tata Steel Ltd’s $875 million convertible issue in August was made on much better terms. The conversion premium was set higher at 35%, and the yield till maturity was much lower at 5.15%. But that seems like an exception. Both 3i Infotech Ltd and Tulip IT Services Ltd, which raised $100 million and $150 million, respectively, towards the end of July, agreed to a yield of over 7%.

But the relatively high yield shouldn’t be a worry, given that the chance of conversion over the five-year term of the bond is high. Suzlon shares have risen by about 30% since the time of the previous issuance. Based on its current price of Rs1,467, the conversion premium on both issuances works out to 23% and 27%, respectively.

The company’s valuation was helped by large orders from the Edison Mission Group and PPM Energy. The order from EMG (630MW) amounted to as high as 27% of the company’s order backlog. The PPM Energy order was for another 400 MW. These large orders have increased the company’s revenue visibility considerably for the next two years, overshadowing concerns that the acquisition of Germany’s REpower AG would impact financials.

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