STOCK DOCTOR | GS Sood | October Issue 2010

http://www.gfilesindia.com STOCK DOCTOR |GS Sood Exercise caution and time your exit THE Sensex celebrated the return to 20,000 amidst doubtful sarkari data of GDP growth, inflation and industrial production which only the foreigners appear to believe since the domestic funds and retail investors have been continuous sellers. According to Jim Rogers, India is no doubt growing and companies participating in that growth deserve generous valuations. But what portion of these valuations is based on fundamentals and what portion is driven by sheer liquidity? The latter aspect is worrying. Central banks in the developed world have been keeping their policy rates low and talk of a new round of quantitative easing is floating around again, leading to a significant drop in interest rates. Excessively low yields have led to a search for higher yields which, coupled with a weaker dollar and high growth rates promised by India, may continue to see the flood of liquidity remaining strong in the near future. The increase in advance tax collections, however, gives some confidence that the performance of Indian companies remains robust. But the valuations with a Nifty PE multiple approaching 26 and the price to book value of around 4 gives little comfort amidst global uncertainties. The deteriorating current account deficit at 3.5-4 per cent of GDP is another reason to worry. A stronger rupee makes matters worse by encouraging imports and discouraging exports. Things are fine so long as foreigners are financing, but the moment their confidence is shaken for reasons beyond Indian control – such as an oil price shock or global developments like the European debt crisis – these inflows will disappear and fast turn into outflows, creating multiple problems. All this may lead to a sharp fall in the markets with the only saving grace being the domestic institutions and retail investors who have ready cash and are waiting for a correction to happen, thereby limiting the likely downside. The Indian growth story has been mainly driven by domestic demand. But measures taken by policymakers to achieve the twin objectives of growth and controlling inflation are expected to curtail growth in the coming quarters. The private consumption demand is seen to be stagnating and government consumption is lower than last year. The credit off-take testifies to this. The growth in bank credit, excluding the telecom and oil companies, is nothing to cheer about. Rather, a large chunk of credit is accounted for by sensitive sectors like real estate. Investors can witness a sharp rally in mid and small caps, but stock selection will be the key. Lots of money can still be made by choosing the right sectors and stocks coupled with the swiftness with which you enter and exit. The banks may be showing a high loan growth but that has more to do with debt restructuring than creating new capacities. The RBI’s Corporate Debt Restructuring (CDR) system has seen a sharp jump in the number of cases of late. As per a report in Mint, the CDR system was dealing with 266 cases at the end of July 2010, up from 239 a year ago. Aggregate debt being restructured also rose to Rs 1,186 billion from Rs 1088 billion during the same period. This makes banks vulnerable to a sharp drop in earnings, exposing them to market losses in a rising interest scenario. This also has serious implications for sustainability of growth. Investors are therefore advised to use abundant caution while selecting stocks. They can witness a sharp rally in mid and small caps in days to come, but stock selection will be the key. Lots of money can still be made by choosing the right sectors and stocks in this segment coupled with the swiftness with which you enter and exit. FDC Ltd(CMP Rs 100) THE company, with an operating history of more than 50 years, is into formulations, synthetics, nutraceuticals and bio-tech with a focus on therapeutic groups of ORS, opthalmologicals, dermatologicals, antibiotics, cardio and diabetes and has well known brands such as Electral, Enerzal and so on. The company, with an R&D focus, has maintained an ROE in excess of 20 per cent for the past 10 years with a top- and bottom-line growth in excess of 15 per cent, zero debt and excess cash position. At an EPS of Rs 8 the stock is available at a PE of just 12.5 as against the industry average of more than 24 with a dividend of Rs 1.75 per share on a Re 1 share. At an index of 20,000 plus, a stock like this, belonging to the traditionally safe sector of pharma, offers moderate to good returns at low risk. The author has no exposure in the stock recommended in this column. gfiles does not accept responsibility for investment decisions by readers of this column. Investment-related queries may be sent to gfilesindia@gmail.com with Dr Sood’s name in the subject line.