Mid-term blues

SMARTSHARE

About halfway through any government's term, it runs out of enthusiasm. The spoils of power have been divided; everybody who is anybody is enjoying themselves at the feeding trough; the next election is too far away to worry about.

The mid-term blues will continue for the next 12-18 months. Given strong growth, it's easy to be complacent. But interest rates are rising, and structural changes, which could make a difference, are unlikely.

The UPA has given up on disinvestment and labour reform. It won't do more than tinker with petro and food subsidies. To its credit, it has made massive commitments to infrastructure and those programmes have developed momentum.

A very small sample of the corporate universe is capable of maintaining current growth rates. According to a recent study by the BS Research Bureau, 40 companies are responsible for most of the profit growth since 2003-04. Eight of these 40 have been consistent performers. That list includes Hindustan Zinc, NMDC, BHEL, Satyam, Maruti, Wipro, Infosys and HDFC Bank.

I'm turning into a bore on the subject of IT and its immunity to high interest rates and a weak rupee. But its heavy representation in this "AAA" list is another pointer to its inherent strength.

IT apart, Hind Zinc and NMDC are base-metal plays. If metal prices fall, so will their profits. Maruti is exposed to rising rates and fuel prices. HDFC Bank is exposed to rising rates.

BHEL's dependent on the power sector, which is in awful shape but improving. The PSU has a full order book for several years to come. That guarantees topline growth.

Importantly, BHEL's credit-cycle will improve since its customer-list includes SEBs (and their unbundled successors), which are now closer to solvency.

The sector's woes could take a decade to resolve. The average unit costs 10-15 per cent more to supply than the average realisation rate. Endemic fuel shortages cause generation bottlenecks and low PLFs. T&D losses are huge. Half the SEBs are bankrupt. Three years ago however, the problems were worse. Maybe 90 per cent of SEBs were bankrupt then, T&D losses were almost 50 per cent higher and PLFs were lower.

BHEL could therefore be a long-term play. The stock isn't cheap. But it can guarantee topline growth and working capital requirements may reduce as the ability of SEBs to pay promptly improves. Other power equipment companies have similarly full order-books. But BHEL has the most SEB exposure and hence, most room to improve.

The other power-sector business worth a close look is PTC. Power trading has grown by leaps and bounds and PTC is a near-monopoly. It is bound to register massive growth in sales volumes over the next two years as more capacity comes online and transmission improve. We've seen signs of this impending volume expansion in the last three quarters.

There are anomalies in the power-trading market. Notably, there's an absurd cap on commissions, which are calculated in paisa per unit rather than as a percentage of unit-cost.

There's scope for a full-scale blow up because the margin system is best described as "punt and hope". But despite the problems, trading is already a profitable business and it must have a future that's far brighter than the past record suggests.

There are very few businesses about which this claim can now be made with much confidence.