It's back to basics time

With the transaction tax issue resolved favourably, the focus reverts to the fundamentals

The markets heaved a huge sigh of relief after the scaling down of the transactions tax. For day traders, for whom the income from trading is business income, the transactions tax will also be treated as a cost and will be offset against business income. In short, it will be status quo ante for them.

For investors, the transactions tax will remain the same as before, except that it will be split into a tax on purchase and one on sales. For mutual funds, fund managers point out that they were unsure whether buying and selling of mutual fund units would also attract transactions tax, in addition to the tax to be paid by the fund when it trades securities.

For the government, transactions tax collections will undoubtedly suffer from the lower rates, and volumes are unlikely to rise to offset this loss.

Some market players, however, point to the lower capital gains tax as a loophole for money laundering, with trades in illiquid counters being the means to convert black money to white by paying a 10 per cent capital gains tax. Some call it a voluntary disclosure scheme in disguise.

The lower capital gains tax more than makes up for the imposition of the transactions tax, a fact amply illustrated by the recent rally in mid caps.

And while it is true that tax losses could be bought to offset the capital gains, that strategy had a cost attached to it, a cost that could be as high as 5 to 8 per cent.

With the transactions tax issue is out of the way, the market can once again concentrate on fundamentals.

Reliance Energy

Reliance Energy's strong profit growth in the previous two quarters cooled off in the June quarter "" growth in net profit was 21.6 per cent.

Moreover, growth in profitability in the June quarter was aided significantly by other income rising 90 per cent. Analysts point out that Reliance Energy had merged BSES Andhra Power and Reliance Salgaocar with itself in the second half of FY04, hence the results of June quarter 04 are not comparable with the previous year.

Sale of energy to households and industries has increased by 22.7 per cent in the June quarter 04. However, the company's cost base has shown signs of rising "" staff cost has risen by 90 per cent in the last quarter and it was largely due to wage revision agreements signed last year. Cost of fuel has risen has risen by 64 per cent, largely due to surging prices of coal on the international markets.

Nevertheless, the company's operating loss rose to Rs 76.05 crore in the June quarter 04 as compared to an operating loss of Rs 23.59 crore in the previous year.

Moreover, MERC's recent order, which would result in a reduction of 8.5 per cent in the average billing rate for REL customers, would be applicable from July 1, 2004, affecting margins. Analysts point out that lower billing rates are expected to be made up by the company through a growth in its customer base.

Interest burden deflates Apollo Tyres

Apollo Tyres reported a 12.9 per cent increase in sales in the first quarter, but net profit fell 16.5 per cent to Rs 15.63 crore. Rising raw material cost (mainly rubber) was expected to hit profitability, but interestingly, that was not the reason for the fall in net profit. In fact, at the operating level, the company managed a 20.12 per cent rise in profit.

Net profit fell only because of a huge jump in interest cost, from Rs 3.55 crore in Q1FY04 to Rs 11.68 crore last quarter. The company had foreign currency loans worth Rs 115 crore at the end of FY04, and the depreciation of the rupee last quarter led to forex losses on the interest payments.

In FY04, when the rupee had appreciated, interest cost was lower by over 30 per cent because of forex gains. Clearly, it's a case of being caught at the wrong end of the stick.

Nevertheless, the main concern for the company going forward is high raw prices. It had taken four rounds of price increases in FY04, but despite that raw material cost jumped 180 basis points (bps) as a percentage of sales.

Thankfully, the "other expenditure" component fell 240 bp on account of better productivity, leading to a 60 bp increase in operating profit margin.

In FY04, all of the company's three tyre plants had increased capacity ""by around 14 per cent collectively. While this should help profitability, rude shocks from rubber prices and the rupee could offset all of that.

With contributions from Mobis Philipose and Amriteshwar Mathur