Signs of overheating

It's not only the midcaps that are hitting new highs

Amid all the hullabaloo about mid cap shares hitting new highs, one interesting fact has got sidelined. The NSE CNX IT index has been hitting new 3-year (closing) highs this week. It was last seen at those levels in early 2001.

What's more, the gain in the IT index since May 18 (the day the current rally began) was 40 per cent, even higher than the 36.6 per cent rise in the CNX Midcap 200 index. Also, while the Nasdaq has been flat during this period, Indian tech ADRs have risen between 40 and 50 per cent.

It's not that anything has changed for tech companies during this period "" the pick-up in volumes had begun long ago, while pricing continue to be 'stable'. It's just that things got worse for other sectors.

While oil prices had skyrocketed, even prices of most commodities were higher, which was bad news for manufacturing companies. Besides, with interest rates set to rise, bank stocks were less favoured.

What's more, IT stocks are largely unaffected by the changes in policy by the government, which is perceived as a serious risk for other companies. It also helped that the rupee had stopped appreciating.

It's not surprising that IT stocks have outperformed the market. But consider the fact that the Midcap index has underperformed the IT index only marginally.

Even within the IT sector, there are mid-caps such as Hexaware, which have shot up to such an extent that it trades at a premium even to Satyam. These could be further signs that mid-cap share are overheated.

Mahavir's Vardhaman unit buy

The objective behind Mahavir Spinning Mills taking over the textiles operations of Vardhaman Spinning appears to be to ensure that production levels are comparable to Chinese competitors and to lower marketing costs, in the post-2005 scenario.

Mahavir had a book value of Rs 194.39 per share and a diluted EPS of Rs 4.36 for FY04 while for Vardhaman it was Rs 202.07 and Rs 3.77, respectively. Each shareholder of Vardhaman will get 0.8 shares of Mahavir and he will continue to hold 0.2 shares of Vardhaman.

Before the merger announcement, Vardhaman was quoting at Rs 224, while the Mahavir stock was at Rs 214. Vardhaman shareholders therefore lost about Rs 10 per share by the swap ratio, and the stock has since corrected. Vardhaman shareholders are peeved, since Vardhaman's book value per share is higher than Mahavir's.

With the anticipated removal of quotas, bargaining power is expected to be vested in the hands of large US wholesalers and department stores, as suppliers from around the world compete for business.

Hence, quality of the overseas client base is key to ensure growth "" Mahavir is expected to leverage Vardhaman's existing client base that includes Target, GAP and Tommy Hilfiger to combat the anticipated increase in competition from East Asian competitors.

Also, combined textile operations will ensure economies of scale in terms of purchasing the key raw material cotton. Analysts estimate that cotton accounts for 60 "" 65 per cent of the cost for producing yarn and any savings on this overhead will directly flow into the bottomline of the company.

Capital goods fuel manufacturing growth

Data for the Index of Industrial Production in July shows that the manufacturing sector continues to do well. The IIP is up 7.9 per cent on a year-on-year basis, and manufacturing growth was at a more modest 7.6 per cent.

That's a decent growth rate, especially when viewed against the smart rise in the manufacturing index in July last year"" the index was at 191.1 in June 2003, compared to 184.0 in June.

The fact that manufacturing has been able to grow so much on the higher base is encouraging. True, the manufacturing index rose by 8.3 per cent in June 2004, much higher than July's rate, but that was because the base was much lower. The impact of this base effect can be gauged from the fact that both the IIP and the manufacturing index for June this year were below the May figures.

Moreover, with the August 2003 IIP being lower than the figure for July, the base effect will also ensure robust growth in this year's August IIP and manufacturing numbers.

In any case, the challenge to industrial growth is likely to come later on in the year, when the effects of a less-than-favourable monsoon kick in after the harvest.

One factor that could offset that decline, however, is a capex boom. The growth in the Index for "Machinery and Equipment other than Transport Equipment" is one way of gauging capex.

That's up a huge 30.2 per cent in July, even higher than its 29.2 per cent rise in June, and well above the 27.6 per cent rise in the cumulative April to July period.

With contributions from Mobis Philipose and Amriteshwar Mathur