Futures tense

The shift to physical delivery for commodity futures needs more mature markets

Commodity futures are likely to move towards compulsory delivery of outstanding positions, which is healthy for the markets so far as it curbs manipulation. The fact that both buyers and sellers would have to compulsorily take or give delivery of the underlying commodity means that speculators would be less likely to influence price by keeping huge positions outstanding. This is main reason why the shift to compulsory delivery has been proposed.

Currently, exchanges follow a practice which gives only the seller of the futures contract the option to settle a contract through physical delivery.

This is because if buyers also had that option, they could squeeze the market by keeping huge positions outstanding, that is when sellers wouldn't be able to deliver the huge amounts of the required commodity.

But that problem will remain even after the introduction of compulsory physical delivery.

If buyers with lot of financial muscle get together and keep huge positions outstanding at the time of expiry, sellers may have to scamper to find enough quantities of the required commodity (that too, the exact grade specified by the respective exchange). This could lead to price distortion in the markets, especially in commodities such as guar seed where supply is less while speculative volume is much higher.

Things could be better only if there are a large number of players in the market, which would make it difficult for a few players to manipulate prices using this route.

The country's top commodity exchanges, NCDEX and MCX are less than two years old, and trading is dominated by end users, which don't form a large group. Experts point out that the shift to compulsory physical delivery should be gradual and must be attempted only after the markets are more mature in terms of turnover and number of users.

The shift to physical delivery would also bring to the fore problems of increased cost associated with taking delivery. Buyers would have to incur a number of expenses like warehousing, insurance, assaying (checking specifications), transportation, octroi, local duties etc. Besides, exchanges offer contracts only in one or two grades of commodities such as sugar or rice.

Often, even traders who deal in other grades use the futures market to hedge risks. Compulsory physical delivery would mean that they would have to take/give delivery of a grade they don't actually deal in. Needless to say, good delivery mechanisms would have to be in place for the shift to be successful.

Bharat Earth Movers

Bharat Earth Movers (BEML) reported a 113 per cent growth in its profit before tax to Rs 19.95 crore in the June quarter, despite net sales increasing by a mere 9.4 per cent. Profit grew at a faster rate mainly because of a focus on higher margin businesses like the earth moving business. The defence division (40-42 per cent of turnover) which consists of supplies of armed recovery vehicles and engineering mine ploughs is very low margin business.

Of course, the upturn in demand from key user industries such as steel and cement plants coupled with irrigation projects has helped the company's earth-moving division. The earth moving division accounted for approximately 55 per cent of total turnover in Q1FY06 compared with 52-53 per cent in earlier years.

Thanks to the shift to higher margin businesses, the company was able to tackle high input costs like that of steel. Raw materials expenses actually fell by almost 200 basis points, accounting for most of the 212 basis points increase in operating margin.

The company has managed to keep staff costs steady thanks to the voluntary retirement scheme VRS programmes implemented in earlier years. The stock, nevertheless, has been more or less flat over the past one month at Rs 650 levels.

The stock trades at 14 times FY05 earnings, which isn't expensive. Nevertheless, the company plans to issue fresh equity shares which will dilute its current equity by 20 per cent, and this could weigh on the stock's performance.

Syndicate Bank

At the upper end of the Syndicate Bank public issue price band of Rs 46 to Rs 50 a share, the price-earning ratio works out to 6, taking the post-issue capital and FY 05 earnings. On pre-issue capital, it's 5.5. That is slightly cheaper than its peers. Even if one takes book value per share, the offer price is not expensive.

True, the bank's net profit during FY05 is lower than in the previous year, but that's because, like all other banks, Syndicate Bank's profits on sale of investments were much lower in FY 05. As far as the core banking business is concerned, the bank has done well, growing net interest income by 18.5 per cent in FY05.

That rate of growth in net interest income was much higher in the March quarter, indicating strong momentum in loan growth. Oustanding advances went up by 29.5 per cent in FY05, while fee income showed a growth of 22 per cent. That growth should offset the pressure on net interest margins.

The bank has also cleaned up its balance sheet through making provisions and by restructuring accounts. Net NPAs as at end-March were 1.59 per cent against 2.27 per cent a year earlier.

Analysts do not expect public sector banks to post very good results for the June quarter, because of the high treasury income notched up in the first quarter of the previous year. But going forward, loan growth, coupled with a moderation of margin pressures and lower provisioning due to reduced NPAs should stand the bank in good stead.

The one problem, however, is that the gap between Rs 50, the higher end of the price band, and the market price of the scrip, currently around Rs 55, is rather low.

With contributions from Mobis Philipose and Amriteshwar Mathur