Circumspection call

The sell-off is a timely reminder of the risks in Wednesday's markets

If low US interest rates and a weak dollar were the reasons for the flow of foreign portfolio investment to emerging markets, then the New Year hasn't been very encouraging to investors. The dollar has bounced back, and is trading near a 2-week high against the Euro and the yen.

US bond yields also moved up, the trigger being the disclosure of the minutes of the last US Federal Open Markets Committee meeting, which showed that the US Fed believes that the rate hikes have not been enough to stem inflation.

The market has interpreted that to mean that rate increases may be bigger going forward. That will affect the "carry trade" "" borrowing money at low interest rates and investing it in a variety of assets such as gold, currencies, commodities and emerging market equities "" by hedge funds.

Base metals, for instance, have been badly hit, with aluminium having its biggest one-day fall in 17 years on Tuesday, and copper prices going down 8 per cent.

The sell-off extended to emerging markets on Wednesday, with the Indian market being the worst hit in Asia. Traders point to the highly leveraged nature of the Indian market as the reason, with very large volumes in single stock futures.

Brokers blame the unwinding of large open positions for increasing the panic. Another reason may be the fact that the Indian market had enjoyed a very strong rally in recent weeks""-that invited a correction.

Morgan Stanley, for instance, has said that the Indian market is 20 per cent over fair value relative to other emerging markets and quotes at a 32 per cent premium on forward earnings relative to other emerging markets.

It is debatable whether the US Fed will be able to summon up the courage to raise interest rates sharply, and the fundamental reasons for dollar weakness remain intact.

But the dependence on speculative capital funded by borrowing will ensure that volatility in all markets will remain high. Wednesday's stock market plunge was a timely reminder of these risks to investors.

Pantaloon Industries

Pantaloon Industries, the fabric manufacturing arm of the Pantaloon group, has picked up a majority stake in Indus League Clothing. The Pantaloon Industries stock, as a result, was locked at the upper end of the circuit filter despite the massive fall in the broad market.

Significantly, Wednesday's was the eighth consecutive session in which the stock closed at the upper end of the circuit filter. Evidently, the markets seemed to know already, even before the company informed stock exchanges last Tuesday, that it would consider some investment proposals in a week's time.

Including Wednesday's gain, the stock has risen 78 per cent since it started rallying last week. Its market cap has risen by Rs 37 crore to Rs 84 crore, which, at first, seems strange considering that the Indus League buyout was worth only about Rs 24 crore.

But control of the Rs 85 crore Indus League would almost double Pantaloon's current turnover of around Rs 90 crore. What's more, the acquisition seems to have come cheap, going by the price-sales ratio of just 0.4 times.

Indus League has strong brands such as 'Indigo Nation' and 'Scullers', and its acquisition would help the Pantaloon group, given its wider distribution reach.

The Pantaloon Industries stock, however, is now rather expensively valued at about 44 times annualised earnings for the nine-month period till December 2004.

But importantly, this company holds about 6.88 lakh shares of Pantaloon Retail, which now has a value of around Rs 50 crore. This alone amounts to a value of about Rs 85 per share for Pantaloon Industries investors. Adjusting for that, the stock doesn't seem as expensive, given the relatively cheap Indus League acquisition.

Sugar

Is the best behind sugar stocks? The latest measures taken to control the rapid rise in sugar prices have resulted in the spot sugar price dropping around 0.5 per cent in Wednesday trading.

Earlier, the NCDEX had enhanced margins on open positions in all sugar futures to 8.25 per cent. And the cooling off of sugar prices led to Dhampur Sugar dropping 6.35 per cent in Wednesday trading and in the case of Balrampur Chini their was a fall of 0.5 per cent.

However, Balrampur Chini and Oudh Sugar fell far less than the Sensex, indicating that the market still believes that sugar stocks will deliver gains.

Sugar prices have gained approximately 20 per cent over the last two months due to reduced supplies "" earlier, the government had released a total free sale quota of 34 lakh tonne for the current quarter which is approximately 13 per cent lower than the previous quarter.

And this sharp rise in sugar prices has not gone unnoticed with the Union minister Sharad Pawar's recently convening an emergency meeting.

The sharp rise in sugar prices had led to an index of sugar stocks compiled by Business Standard Research Bureau rising 61 per cent since the last 2 months, vis-a-vis a growth of 9 per cent in the benchmark Sensex.

However, with Balrampur Chini trading at a P/E of around 20 ( trailing 12 month earning) and Dhampur Sugar Mills at 37, these stocks look expensive given the first signs of weakening sugar prices. And with the rise in price of this commodity clearly on the government's agenda, it could result in a further softening of sugar prices and more realistic levels for sugar stocks.

With contributions by Mobis Philipose and Amriteshwar Mathur