Gains and valuations

GUEST COLUMN/ TORCH-LIGHT

At a time when the key market indices seemed stuck in a sideways twirl, two public issues - Power Trading Corp (PTC) and Bank of Maharashtra (BoM) - took the wind out of the market.

Though both the issues were expected to do well, the extraordinary gains they registered on listing surprised most. Do these companies merit the kind of valuations they enjoy? If not, what is driving such frenzied valuations?

PTC entered the market on March 1, 2004, with a book-built public issue of 5.84 crore equity shares of Rs 10 each, in a price band of Rs 14-16 per share. The discovered price was Rs 16 per share.

PTC is jointly promoted by PGCIL, NTPC, NHPC and PFC. It has created a niche for itself by becoming the first company to successfully trade in power in the country. It sources power from surplus power generating entities and supplies it in areas where there is a shortfall.

PTC's USP is its well-established working relationship with various state electricity boards (SEBs). Besides, the cost-plus formula it works on has protected it from any significant market price discovery risks.

The company is raising funds to strengthen its long-term capital base. It will also benefit in the form of better cash flows to close larger procurement deals in advance against anticipated demand. PTC is also well-positioned to explore opportunities arising from the export of power from Nepal, Bhutan and Bangladesh.

Though PTC's financial picture appears fairly rosy with sharp growth in both topline and bottomline over the past couple of years, it has chosen to defer a write-off of its developmental expenditure to Rs 9.39 crore.

Besides, there is the issue of a potential conflict of interest with one of its promoters, NTPC, which has set up a 100 per cent subsidiary engaged in the business of trading in power. PTC's real test will, however, come when a competitor emerges.

Considering that potential competitors include the likes of the Tatas and the Reliance group, there could be a slug-fest in the offing.

PTC sits pretty for now and will in any case retain the first-mover advantage. Based on the fully diluted post-issue equity base, the P/E multiple for the company at the price level of Rs 54 approximates 27 while the P/B approximates 3.

This does suggest that the stock valuation is fundamentally stretched, but as long as institutional appetite for the stock remains unsatiated, its risky northward journey could continue.

BoM made a public issue comprising 10 crore equity shares of Rs 10 each, priced at a premium of Rs 13 per share, aggregating Rs 230 crore on February 25, 2004. It's a western Maharashtra-centric medium sized regional bank.

Over the last five years, BoM's deposits and advances have grown at CAGRs of 19.4 and 21.5 per cent respectively. The bank has computerised about 92 per cent of its business and had 45 ATMs at the end of FY03. Its capital adequacy ratio appears healthy at 12 per cent against the RBI prescribed mandate of 9 per cent.

On the flip side, the bank's domain of influence is limited to western Maharashtra. There may be an asset-liability mismatch unless the bank expands its geographical spread. Besides, the bank's gross and net NPA levels of 9.5 and 4.8 per cent are high and compare unfavourably with most of its peers.

Given that these NPAs will inevitably need provisioning, the road ahead on the profitability track for BoM does not appear broad. NPAs also cast a shadow over the bank's profitability.

Considering these factors, the historical P/E of 8 plus based on FY03 results balloons, making BoM a clearly overpriced stock at the Rs 43 level.

Given that there is a renewed frenzy for banking stocks, the stock price of this relatively weaker bank has held out, though that by itself does not in any way minimise investors' risk, especially at these dizzying levels. The likeliest salvation for the bank could come through a takeover which could give its share price yet another spike.

Simply put, PTC and BoM have run well ahead of their fundamentals. However, given that the market has this habit of dropping overvalued stocks harder, retail investors should think twice before venturing into such stocks.

Of the two, PTC is the more promising story, but at the end of the day, a simple question that must be asked is: Are these valuations justified? The answer to that question should in many ways determine your decision whether to buy, sell or hold these stocks.

Do these extraordinary listings bode well for the markets? Well, yes, to the extent that there will be more 'gold-seekers' flocking thereto. But the flip side is: It will inevitably blinker the vision of some promoters and merchant bankers who are likely to get tempted into pricing their issues as aggressively as possible.

Now, that in turn could lead to poor listings which in turn could end the ongoing primary market party. After all, it's not prudent to kill the goose that lays golden eggs!

(The author heads Lotus Strategic Consultants, Mumbai, and can be contacted at ceolotus@hotmail.com. Disclosure: He has no outstanding interest in the companies discussed here.)