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Caution should be the watchword for IT stocks

Who would have thought an information technology share would return to the heady levels reached during the tech boom of 1999-2000? Well, the Infosys stock has done just that.

Its current price of around Rs 2,130 is almost three per cent higher than the highest level the stock had reached in early 2000, after adjusting for a stock split in 2000 and 3:1 bonus last year.

Adjusted for these, the highest price of Rs 16,875 reached on the National Stock Exchange in January 2000 would effectively have a value of Rs 2,109 per share.

To put it differently, Infy is currently valued at Rs 17,320 per share, if one were exclude the impact of the stock split and the bonus issue.

In this respect, the Infy share is part of a rare club, since no other (prominent) IT services scrip has achieved this feat. In fact, other frontline IT stocks such as Wipro and Satyam are way off their 2000 highs.

For both, the difference between current prices and the 2000 highs is more than 70 per cent. But that's more because the levels these stocks had reached in 2000 were more absurd relative to Infy's.

That apart, there's no denying that IT stocks have risen considerably in the current rally and are now rather richly valued. The top three stocks, TCS, Infy, and Wipro all trade at over 30 times estimated FY05 earnings.

Also, all three stocks get revenue multiples of over 6 times - in Infy's case, it's even higher at 8 times. This, coupled with signs that sales and profit growth could be peaking, calls for some caution.

Hindustan Motors

The spinning off of the components business of Hindustan Motors into a separate company marks a big step in Hindustan Motors' turnaround plans.

The move will not only infuse much-needed cash ""- Rs 265 crore "" into the company, but it will also lead to an increase in the company's net worth by Rs 140 crore, which should wipe out the company's accumulated losses of Rs 105 crore as in March 31, 2004.

Hindustan Motors will continue to retain 49 per cent in the new company AVTEC, in which Actis will have 30 per cent and the promoter group 21 per cent.

That would mean that it retains the considerable upside in the components business, which is expected to record sales in the region of Rs 375 crore this fiscal, compared to Rs 95 crore in FY 04.

The business is growing rapidly and is the profitable part of Hindustan Motors' business""-in the first half of this year, the company's automatic transmission segment notched up a profit of Rs 13.6 crore on sales of Rs 54.1 crore.

Part of the cash from the hive-off will be used to develop the forgings and castings based components business at the company's Uttarpara plant, which should have good growth prospects.

The worry, of course, remains the automobile business, which had a net loss of Rs 23 crore on sales of Rs 361 crore in the first half. Turning this division around will be difficult, in spite of the new models being planned.

Nevertheless, the company has shown net profits in the third quarter after a long time. Much depends, however, on whether the momentum is sustained.

A closer look at the figures show that net sales actually were lower in the December quarter than in the September one, and operating profits rose sequentially because of lower expenditure.

Also, interest costs rose in Q3 compared to Q2, so using a part of the cash from the spin-off to reduce debt, as promised by the management, will help.

The Hindustan Motors stock has trebled since last September. The upside from the deal with Actis is more than adequately factored into the price.

Mahindra & Mahindra

Mahindra & Mahindra's (M&M) joint venture with the French auto major Renault to manufacture the low-cost sedan, Logan, should have happened much earlier.

Nonetheless, the Indian passenger car market continues to boom; aspirations are soaring and relatively low interest rates and attractive financing schemes are helping fulfil these aspirations.

And the "C" segment, in which the Logan will feature, has been one of the fastest growing segments. In 2004 this segment saw sales of 1.72 lakh up 38 per cent over 2003.

The C segment has about a dozen models and M&M will be looking to take on undisputed segment leader Tata Indigo whose diesel version has been a spectacular success.

Honda City, too, will be tough to compete with, and there's also Ford's Ikon and Hyundai's Accent. Perhaps an attractive invitation price will do the trick. And a diesel version is a must.

The Logan should find buyers "" Indians love cars with boots "" but its conventional looks might compel M&M and Renault to also cater for semi-urban customers.

Besides, the Renault engine may not necessarily give it an edge, though the fact that the car will roll off the assembly lines only next year will ensure that it meets the latest emission norms.

For M&M, which already has the distribution network in place, it will be a learning experience since it has never sold passenger cars. Its utility vehicles, the Scorpio and its predecessor the Bolero, have been successes so the company should not falter especially since it has a strong partner in Renault.

As a company, M&M badly needed more products to diversify its business and the Logan appears to be a viable option. The $100 million that it had picked up through FCCBs early last year will come in handy.

With contributions by Mobis Philipose and Shobhana Subramanian.