Corporate Finance: The Great Indian Stockmarket

Is this bull run for real? Or is it just another short-lived spurt that will soon peter out? With foreign investors charging in, and India's economy showing the first positive signs of a recovery, the rally on the stockmarkets looks like it is here to stay. Neither the elections around the corner nor a growing fiscal deficit will dampen the spirits-and the Sensex-on Dalal Street. For now. BT presents The CFO's Guide To The Stockmarkets.

There are 2 ways of feeling the pulse of The Great Indian Stockmarket. You can do the conventional monitoring-the-Sensex-on-the-Reuters-screen and pore over forecasts prepared by investment banks with double-barrelled names. Or, you could do the smart thing: hop across to Dalal Street and check out the sales at any of the vegetarian-snack joints across the road from the Bombay Stock Exchange's (BSE) 23-storeyed skyscraper that looms large over everything else in South Mumbai. If the pao bhajis are selling like-don't mind the mixed metaphor-hot cakes, that is it: the Sensex (BSE Sensitivity Index) must be on the rise.

Ever since the Sensex touched an all-time high of 4,710.25 on July 15, 1999, the pao bhaji-wallahs have been doing brisk business. And, whether or not you believe the correlation, the bulls on the Indian bourses have been vying with each other to predict what new peaks the Sensex will reach before the end of the millennium. Estimates range between a cautious 5,000 to a thunderingly-optimistic 6,000-plus. Jardine Fleming expects the Sensex to touch 5,000 by December, 1999. So does HSBC Securities, which predicts that it might even breach 6,000 by March, 2000. Reckons Surjit Bhalla, 51, Director, Oxus Fund Management: ''The Sensex should hit 6,000 by the time the next Finance Minister presents his budget.'' Nevertheless, everyone is unanimous on one point: this bull-run is for real. And, this time, it will last-at least for a while.

'THE FUTURE BELONGS TO MID-CAP STOCKS'

The infotech boom that the stockmarkets witnessed recently is unlikely to continue for long as the mid-cap stocks will rule the bourses in the next couple of months.

Foreign investors, who have seen the meteoric rise of infotech stocks on Wall Street, would like to believe that the Indian infotech stocks have a long way to go as they are relatively cheaper and, hence, have a lot of ground to cover. But I don't think that will happen.

The general elections scheduled for August-September, 1999, will have a negligible impact on the stockmarkets. Most issues have a limited degree of influence, and politics is certainly one of them. The Indian bourses are mature enough to discount negative factors and focus on the essentials.

Select stocks will continue to move up, but the kind of broad-based frenzy that we have seen over the past year is not sustainable in the long run. The future clearly belongs to mid-cap stocks, whose value and potential have remained untapped. I see foreign investors continuing to play a greater role in the stockmarkets. India has a lot of potential, and there is a great deal of money to be made. Foreign investment is likely to keep pouring in.

What makes them so sure? A lot of things. First and foremost is the increased interest that the Foreign Institutional Investors (FIIs) and global fund-managers are showing in the Indian stockmarket. Beginning April 1, 1999, the FIIs have been pumping in money into Indian stocks. Between April and July, 1999, the net FII inflow was $960 million (Rs 4,130 crore). In July, 1999, alone, it recorded $333.10 million (Rs 1,399.02 crore), up from a measly $20 million (Rs 84 crore) in June, 1999. The FIIs' bullishness about Indian paper is part of the resurgence of the Asian stockmarkets. With the Dow Jones Index ruling at 11,000, and showing little signs of slowing down-forecasts suggest it could even end the year at 12,000-plus-American fund-managers are flush with surplus money. And what better avenues to channel them than the resurgent Asian stockmarkets. ''The FIIs have become more than just a force to reckon with. The current revival is driven primarily by them,'' gushes the 53-year-old Hemendra Kothari, Chairman, DSP Merrill Lynch.

However, there's something special about the Indian stockmarket. The FIIs believe that, compared to other emerging markets, Indian stocks are undervalued. Based on their projected 1999-2000 earnings, the average Price-to-Earnings (P-E) multiple for the scrips quoted on the BSE, at 14, is lower than Indonesia's 16.60, South Korea's 22, and Malaysia's 23.80. Claims Ajay Srinivasan, 35, CEO, Prudential-ICICI: ''A lot of Indian stocks are definitely available cheap, whether they are cyclicals or high-performers like Hindustan Lever and Infosys. Companies in certain sectors, like media and cable, trade at much higher P-Es of over 50 in South-East Asia. So, from that perspective, Indian stocks are undervalued-and cheap.''

But there's another reason for the FIIs' current crush on the Indian stockmarket. They seem to appreciate the fact that the country's corporate sector is, finally, refocusing its businesses and, in an unprecedented wave of restructuring, moving out of non-value added businesses, sticking only to those that do. International investors love focus-and Indian corporates are giving them just that. Explains U.R. Bhat, 46, Chief Investment Officer, Jardine Fleming India Broking: ''The FIIs are not buying stocks just because companies are doing well today. They are buying because their restructuring activities today will lead to better performances tomorrow.''

'GOOD RESULTS WILL BENEFIT THE BOURSES'

Over the next 12 months, the Sensex is likely to peak at the 5,800 level driven by good corporate performance and sound macro-economic fundamentals. Elections are not really an issue. It is too early to speculate on what is going to happen. But the general feeling is that irrespective of the party that will come to power, the government is going to be less shakier than the previous ones. Everybody expects a coalition government at the Centre. So, the stockmarkets will not crash even if the BJP is not able to garner a two-thirds majority.

A note of caution: if the fiscal deficit overshoots its target and the government has to step up its borrowing programme, interest rates could rise and we could go through the same cycle again-crashing stockmarkets and regression in the economy. However, with the markets looking up at the moment, the government's much-planned disinvestment programme could take off and it could actually be looking at meeting some of its targets.

Good corporate performance is what is likely to drive the stockmarkets up-with elections and other issues taking a backseat. The rally over the next year will be led by the infotech, FMCG, and cyclical stocks. Cyclicals are likely to do well, especially chemicals, engineering, automobiles, and cement.

Already, yesterday's pariahs are today's pets. After the A.V. Birla Group restructured Grasim Industries' portfolio by consolidating its cement business, the once-shunned conglomerate has become a darling of the FIIs. Grasim is currently valued at a multiple of 14. 30 on 1999-2000 earnings and, on 2000-01 earnings, it is trading at 11.30 times its earnings. Although its historic p-e has never crossed 15, analysts believe that there is scope for growth. On July 26, 1999, Grasim closed at Rs 310. Likewise, the B.K. Birla Group's flagship, Century Textiles' decision to restructure its cements business has led to its scrip-price zooming from Rs 22 a year back to Rs 70 at present.

What has helped bolster the FII interest are good Q-1 results. The beginning of a recovery in cyclical industries, like cement, petrochemicals, and automobiles, has spurred renewed interest in such stocks. A BT study of 211 companies indicates that first-quarter sales and net profits have logged increases of 14.80 and 27.10 per cent, respectively, over the corresponding period of last year. In 1998-99, sales of these 211 companies grew by just 9.50 per cent while profits rose by 12.70 per cent. Avers Brian Brown, 37, Managing Director, Indo-Suez W.I. Carr Securities: ''The stockmarkets are discounting good corporate performance over the next one year.'' Adds Kamal Parekh, 51, President, Calcutta Stock Exchange (CSE): ''This year's Q-1 results have been good; interest rates are coming down, and inflation is down to its lowest levels.''

Indeed, because they feel that the fundamentals are in fine-fettle, the FIIs are expected to remain bullish on India in the near future. Reckons Ridham Desai, 31, Vice-President & India Strategist, J.M. Morgan Stanley: ''Our 12-month Sensex target of 5,800 reflects rising corporate earnings and an improvement in valuations. We think an improving macro environment of low inflation, rising growth, a benign interest rate environment, and strong market dynamics are supportive of valuations.''

Some dyed-in-the-wool bulls expect the surge to last for at least 3 years. Maintains Vivek Reddy, 36, CEO, Kothari Pioneer Asset Management: ''The fundamentals are strong, and there are many undervalued companies that are yet to be fully capitalised. Also, economically, India is looking better than other Asian countries, and there is more liquidity in the stockmarket.'' What's also driving the bulls is that, this time, although the Sensex's rally has been led by the usual bunch of hot stocks-FMCG leader Hindustan Lever, infotech major Infosys, and pharma star Ranbaxy-the bull-run has cut across categories. Commodity stocks like aluminium and cement have surged. TELCO's scrip-price, for instance, has jumped from Rs 163 in January to Rs 250 in July, 1999; Grasim's from Rs 180 to Rs 310; and that of Reliance from Rs 119 to Rs 170.

One of the biggest gainers has been Larsen & Toubro (L&T), more than doubling from Rs 161 to Rs 330. The S&P CNX Index for two- and three-wheelers has risen by 33 per cent from 1,503.98 on January 1, 1999 to 2,001.66 on July 27, 1999, while, for cement stocks, it moved up 69 per cent from 424.06 to 717.12, for aluminium by 43 per cent from 569.95 to 818.37, and for four-wheelers by 73 per cent, from 610.62 to 1,059.42.

So, focusing on the 30-share Sensex alone may not provide a clear picture since Sensex is dominated by a handful of scrips which are always volatile. For instance, if Ranbaxy (which has a weightage of 3.77 per cent in the Sensex), Infosys (5.70 per cent), and Hindustan Lever (23.53 per cent) were removed from the Sensex, its closing value on July 26, 1999, would have been 3,105 instead of 4,625. Says Srinivasan of Prudential ICICI: ''That's quite true. But a better way of looking at it would be to focus on how Grasim, L&T and Indian Rayon have been growing. They have fetched better returns for investors than the highly-priced stocks which have anyways been top performers. Also, the number of scrips that have gone up is much higher.'' True. For, the number of scrips that advanced on the BSE on May 12, 1999, was 424. By July 9, 1999, that figure had more than doubled to 989.

Bulls hate red. Especially, if it happens to be splashed all over company's bottomline. But, evidently, they love saffron. With General Elections kicking off in less than a month, and the Bharatiya Janata Party (BJP) looking confident after the Kargil conflict, big investors expect a stable government at the Centre. And one that many expect to be BJP-led. Says Indo-Suez W.I. Carr's Brown: ''The market mood is positive as it feels that the BJP has gained some ground after the border conflict.'' Adds cse's Parekh: ''The Sensex can cross the 5,000-mark if we have a stable government after the elections.''

'ALWAYS LOOK AT INDIVIDUAL STOCKS AND THEIR VALUES-NOT JUST THE INDICES'

I will not hazard a guess on the Sensex. I think one should look at individual stocks and their value-not at indices. An investor's primary consideration should be how much, she thinks, will a certain company reward her. The rewards may come through either dividend or capital appreciation. For instance, she could buy a scrip which is quoting at Rs 25 while the Sensex is at 5,000 points. Even if the Sensex comes down to 3,000, the valuation of the scrip may not change drastically.

The markets are definitely maturing; investors are now buying scrips of companies that they think will reward them adequately. At the companies that they think will create shareholder value and wealth, such as those belonging to the the infotech, pharma, and FMCG sectors. FII buying has continued despite the uncertainty over the elections. I don't see a downside because we survived the Kargil conflict when the bourses showed a lot of stability.

Investors will continue to buy stocks, and continue to be rewarded. A correction is already taking place. Where the market moves will depend on various macro-economic indicators. So, the post-monsoon indicators will lead to the next rise. The market, worldwide, moves on news. Remember, information is the key.

Yet, curiously, the stockmarkets do not expect the elections to impact the trading sentiment. Says CSE Stockbroker, Rajendra Agarwal, 40: ''Historically, the stockmarket has reacted adversely before elections, and that may happen even this time, given people's expectation regarding the post-election situation and a coalition government. But still I don't feel it will be a major correction.'' To be sure, in the last 2 elections in 1996 and 1998, the stockmarkets did not react violently. And that despite a politically-unstable environment.

In November, 1997, just a month after the I.K. Gujral Administration fell, the Sensex was hovering around 3,750. In January, 1998, when the elections were announced, it began to move up to touch 4,322 in April, 1998, and stayed at those levels till the time the new government was in place. Earlier, in 1996, even before the General Elections were over, the Sensex had started rallying. From a low of 2,872 in January, 1996, it peaked to 3,607 in February, 1996, before dropping to 3,242 in March and then bouncing back to 3,800 when the elections took place in May, 1996. By June, it had peaked at 4,131.

With elections around the corner again, the Sensex is now hovering at 4,600, and few expect it to react wildly. Says the controversial former BSE Stockbroker, Harshad 'Big Bull' Mehta, 44: ''Every issue has a limited effect on the stockmarket these days. It's the same with politics. The Indian stockmarkets are becoming more mature and capable of digesting all the negatives.'' Still, the stockmarkets are expected to soar if a BJP-led government is voted to power. ''If the BJP wins, the stockmarket will regard it as a big plus, and that could act as the next trigger to take the markets further up,'' says Indo-Suez W.I. Carr's Brown.

Traditionally, when the secondary market booms, the primary market wakes up. Only, if it isn't already dead. For, in the last 3 years, the market for Initial Public Offerings (IPOs) has been all but dead. If the stockmarket shakeout has taken its toll on any community, it has been the merchant bankers. With primary issues drying up, large numbers of them have been wiped out-or crippled. In 1996-97, there were 753 public issues that raised a total of Rs 11,648.20 crore (net offer to public was Rs 8,583.65 crore). In the next year, there were none; and, in 1998-99, just 4 companies raised Rs 40 crore. Dismal.

Now, the good news. Over the next few months, nearly Rs 280-300 crore worth of new issues are slated to hit the stockmarket. Along with the usual software and bank IPOs, there are manufacturing companies and big names, like the Videsh Sanchar Nigam, that have queued up with public issues. Taking a cue from the revival of the equity markets, the financial institutions like the Industrial Development Bank of India are planning to ask big projects like the Haldia Petrochemicals Complex to explore the possibility of making an IPO to bridge its equity gap. The Haldia project needs over Rs 900 crore as equity, and 2 years of trying to rope in a strategic partner have proved futile.

'BLUE-CHIPS WILL DO EVEN BETTER'

The economy is recovering although it has not been reflected in the movement of the Sensex. Another 3-9 months of sustained economic recovery will see the Sensex rising northwards to the 5,000-5,500 level by March, 2000. The onset of elections may see some small corrections and short-term weaknesses, but the polls are unlikely to dictate the pace of the rally in the stockmarket.

The rally is broad-based and not dictated by a few leading players like Hindustan Lever, Infosys, and Ranbaxy Laboratories. The prices of many quality stocks have appreciated, and there are excellent opportunities for making money. The first-quarter results of most corporates have been in tandem with expectations. There have not been any major surprises. Over the next 3-9 months, the blue-chips will perform even better and their stockmarket valuation is bound to increase.

Investor interest in mutual funds is likely to increase over time. We have also been witnessing a lot of institutional interest. I don't subscribe to the theory that the current rally is being led by only a few companies; a lot of cyclical stocks have been doing well too.

Does that mean merchant bankers can pop the corks? Probably not. While it's true that the stockmarket has improved, investors have become sharper. Recent IPOs haven't been a cakewalk for their promoters. Some of the recent IPOs, mostly infotech, have done fairly well. Sonata Software's Rs 22 crore IPO was priced at Rs 90 per share and is currently trading at Rs 402.95 (July 27, 1999), a gain of more than 4 times. Explains Ishaat Hussain, 51, Executive Director, Tata Sons: ''The stockmarkets have become much more demanding; they are not willing to finance just about anybody. Companies need to be clear and think hard before raising money from the stockmarket.''

Such caution notwithstanding, few doubt that the current stockmarket rally is for real. Even chartists with their cut-and-dried stochastic analyses feel that the uptrend can be sustained, if not across all sectors at all times, at least by some of them. Says Dharmesh Rajdev, 33, a technical analyst at the Calcutta-based stockbroking firm, C. Mackertich: ''The boom is more sector-specific, led by the cyclicals, infotech, and pharma stocks. So, at times, the cyclicals are overbought while the software sector is down and vice-versa at others.''

But unlike elephants, investors have short memories. And bulls have even shorter ones. So, it will serve them to remember that stockmarket rallies sometimes turn out to be kill-joys. They don't last long enough. The last big bull-run that began in May, 1994, sputtered to a halt in 9 months and, in mid-1997, when the Sensex started rising to cross 4,500 in August, by year-end, it was down to 3,300. Could it happen this time as well?

No way! That's what emphatic bulls will say. This time, they could be right. Because of the fundamentals. Capital is flowing and stockmarkets are moving since the underlying economic fundamentals are changing. In spite of the impending elections and despite Kargil, activity levels in the real economy are cranking up. Exports are up, tax-collections are buoyant, the railways are hauling more revenue-earning freight, and factories are humming. The Index of Industrial Production (IIP) spurted by 7.20 per cent in May, the highest in 16 months. Better still, the recovery is spreading. Spurred initially by a turnaround in cement despatches and a pick up in housing activity, the recovery now includes the steel, aluminium, industrial machinery, automobile and other consumer durables industries-all of which recorded double-digit growth rates in the first 2 months of the fiscal.

Credit the better performance to a pick up in both global and domestic demand. As the Asian economies claw their way out of crisis, demand-supply imbalances are evening out. Already, global commodity prices have firmed. And on the domestic front, 2 good agricultural cycles (the bumper kharif and rabi harvests of 1998-99) and the prospect of yet another good kharif crop has pulled down inflation rates and raised purchasing power. Tellingly, the fastest growing segment of the IIP has been consumer durables. During the first 2 months of the year, consumer durables production shot up by a dizzying 18.90 per cent. Observes Indira Rajaraman, 51, RBI Professor, National Institute of Public Finance and Policy: ''This is a revival that is being led by rising consumer demand, especially rural demand.''

But the downside is high interest rates. At around 8-10 per cent a year, real interest rates (nominal interest rates minus the expected rate of inflation) in India are amongst the highest in the world. With competition increasing, companies cannot pass on higher financing costs to the consumer, further squeezing already thin margins. Worse, stockmarket valuations remain low since future earnings are discounted at high rates.

Normally, falling inflation should lead to falling interest rates. But, in the Indian economy, interest rates have remained rigid for 2 related reasons. First, a burgeoning fiscal deficit is consuming a growing share of available funds, creating upward pressure on interest rates. Already, during the first 2 months of the year, the deficit has swelled to Rs 22,011 crore, nearly one-third of the budgeted amount of Rs 79,955 crore.

Second, to attract small savings and postal deposits (which are used to finance state government deficits), interest rates on these deposits are kept high. Currently, they are pegged at 11.50 per cent. That sets a floor, below which interest rates cannot fall. Warns Oxus Fund Management's Bhalla: ''Unless we move from babu-determined interest rates to market-determined ones, the rally will fizzle out.''

The mere suggestion of a fizzle-out makes Dalal Street's snorting bulls bristle. Declares J.M. Morgan Stanley's Desai: ''The 1999 bull market is different from 1994. Our positive view of the stockmarket is reinforced by 3 critical differences: sustainability of economic growth, cheaper valuations, and favourable demand-supply for equities.'' The facts bear him out. In 1994, when the Sensex peaked at 4,600, its combined price-to earnings multiple was 22. Today, the multiple is just 14, but the Sensex is ruling higher. Touch�. Or, should we say, Ole?

Additional Reporting By Rukmini Parthasarathy, Ranju Sarkar & Rakhi Mazumdar