Feeling the pinch

Small cap stocks continue to be shunned by markets

No prizes for guessing which of BSE's 17 indices fared the worst in the correction last week. The BSE Small Cap index fell by 11.1 per cent between the market's peak last Tuesday and the fall on Thursday, more than three times the rate at which the Sensex fell.

Except for the FMCG index, which gained thanks to a sharp, unexplained jump in the price of ITC, the Sensex was the best performing index. All other sectoral indices underperformed, signifying that sticking with a diversified large-cap portfolio could be the best strategy in these times.

Small cap buffs would be quick to point out that the Small Cap index has also seen among the fastest rebounds since. The index has risen over 6 per cent, higher than the Sensex's gain of 4 per cent.

But what's important is that despite the bounce back, the Small Cap index continues to be about 5.7 per cent below the peak it had reached last Tuesday. The large cap Sensex, on the other hand, is busy hitting new life-time highs.

Actually, the plight of small cap stocks, as a category, is much worse than what BSE's Small Cap index portrays. A large number of small cap stocks (especially those in the trade-to-trade and 'Z' categories) continue to hit the lower end of the circuit filter.

At the end of trading on Wednesday, 33 per cent of the stocks in the trade-to-trade category of stocks of the BSE were stuck at the lower end of circuit filter.

Things were worse in the 'Z' category, in which about 52 per cent of the stocks in the category were stuck at the lower end of the circuit at the end of trading. In fact, the scenario's been pretty much the same everyday since last Wednesday.

Apart from small caps, BSE's consumer durables, metals, mid cap, and IT indices have been among the worst performers in the past week. Stocks that are part of these indices have either run up sharply in a short time, or have enormously high PE multiples.

The message from the markets is pretty clear: stay clear of small cap stocks, and ones that have risen sharply or have high valuations.

MTNL: domestic focus needed

Taking a leaf out of VSNL's book, MTNL and BSNL are now foraying overseas. While VSNL plans to tap the emerging opportunity in South Africa, offering wireless and limited mobility services in association with some local players, MTNL is exploring options in Sri Lanka, Africa and the Saarc countries. In Sri Lanka, it is looking to offer data and basic telephony operations.

MTNL's share of the cellular space in India is just about 2 per cent - it has 1.2 mn subscribers - despite the fact that it operates in the lucrative Mumbai circle. It hasn't made much of the rapid growth in the cellular subscriber base in the last three months. For instance, while the industry grew at 4.4 per cent in August, MTNL grew just 2.5 per cent.

Not only has MTNL not made too much headway in the mobile space, it also lost around 29,000 fixed-line subscribers in August, at a time when competitors have added to their subscriber base.

While overseas expansion is welcome, analysts feel that MTNL should focus more on the domestic market, which is much bigger. The broadband business, for instance, is expected to see explosive growth in the next few years. MTNL has the enviable 'last mile advantage" in cities such s Mumbai and Delhi, which it could exploit.

Dr Reddy's Laboratories: A stitch in time

Dr Reddy's Laboratories (DRL) has taken another step to bring R&D costs under control. As part of the latest deal, Dr Reddy's has roped in two venture capital players to set up Perlecan Pharma. The new company would be eligible for commercial rights of molecules that are brought to the market.

While this deal will further reduce Dr Reddy's risk profile, it does underscore the fact that the company's shareholders would have to share the large income and profit streams that are typically generated on successful commercialisation of a new molecule.

The markets, therefore, didn't seem too excited and the DRL stock ended the day flat. Nevertheless, DRL's earlier agreement with ICICI Ventures did help it cut R&D costs by 21.4 per cent to Rs 44.41 crore in the June quarter.

Analysts highlight that partnership models have shown their efficacy at a time when generic players have been dealing with pricing pressures in the key American market. Take Cipla, for example, which has been growing profits for the past several quarters as it avoids large marketing and allied costs in overseas markets, thanks to its partnership with foreign players.

Analysts expect other large generic players to also look at innovative avenues to de-risk their drug discovery process. DRL, meanwhile, is expected to benefit once again in the September quarter from its strategy of diversifying its export base beyond the difficult North American market into emerging markets like eastern Europe and CIS countries.

As a result, the company is expected to grow profits by 25-30 per cent in the September quarter, point out analysts.

With contributions from Mobis Philipose, Shobhana Subramanian and Amriteshwar Mathur