Liquidity squeeze

Banks do not lend during the end of the financial year

The investment portfolios of banks are likely to get hit due to lower valuations as the financial year comes to an end this week. The depreciation will be more pronounced in case of corporate bonds as compared with government securities.

There has been a further tightening of liquidity in the money market since the advance tax outflows seen last week as auction outflows of Rs 6,000 crore are slated to be held this week.

Even if the government has assured that it will spend about Rs 21,000 crore during the week, it is to be seen how the RBI will deal with this money coming in the system as inflation is expected to remain above 6 per cent till April 6.

Most of the banks, on the other hand, do not prefer lending in the market during the end of the financial year as it attracts full provisioning of capital at nine per cent capital adequacy.

Therefore, banks have taken a cautious approach to trading in the market. Even if they may engage in trading to raise the price of the 10-year benchmark and push the yield down, the effect will be more evident for the private and foreign banks whose asset size is small, and lack the cushion that the larger PSU banks.

The 10-year benchmark paper had closed in March 2006 at over 7.5 per cent, and is now trading at around 8 per cent.

If the liquidity situation does not ease and banks continue to clamour for additional funds for provisioning, it may easily shoot up above 8 per cent. Incidentally, the year end closing is clashing with the reporting Friday, which often turns chaotic when money is tight.

The negative impact of the valuation on the corporate bond will be much more since the spread between the 10-year gilts and the triple A bond of similar maturity has gone up from 70-80 basis points last year to 150 basis points this year. Most of the public and private sector banks have built up considerable portfolio of corporate bonds, which will be hit to that extent.

Flat tyre

For tyre companies, Q4 FY07 is likely to be a difficult quarter, as spot rubber prices in this quarter till date have averaged Rs 95 per kg levels as compared to an average price of Rs 78.4 per kg in Q4 FY06.

Higher rubber prices this year are attributed to unfavourable weather conditions in key South East Asian producing countries, coupled with buoyant demand conditions from China, say analysts.

For a tyre company, rubber as a percentage of net sales typically constitutes about 65 per cent of sales, and in a bid to minimise the impact of higher input price, tyre companies employ hedging strategies.

Analysts point out that tyre companies had last hiked prices in July 2006. Rising input costs have not gone unnoticed by the street, with tyre stocks under-performing since the beginning of Q4 FY07 - Apollo Tyres has declined a whopping 25 per cent during this period as compared to a 7.6 per cent fall in the Sensex. MRF too had declined 24 per cent during this period.

In contrast, in the December 2006 quarter, stable rubber prices had helped players like Apollo Tyres to improve their operating profit margin by 285 basis points y-o-y to 10.8 per cent.

The current uncertainty in rubber prices has resulted in Apollo Tyres trading at 9 times estimated FY08 earnings, while JK Industries is at 5.5 times estimated September 2007 earnings.

Satyam: Deal jolt

Even a sizeable deal like the five-year $200-million contract from the US-based semiconductor equipment and services company Applied Materials did not help the Satyam stock much on Wednesday.

Stocks like TCS and HCL Technologies fell over 4 per cent and the CNX IT index declined 3.7 per cent, Satyam did slightly better at 3.5 per cent.

While the jury is still out on the impact of a US slowdown on Indian tech companies, it is the appreciating rupee, which has spooked investors as it will have a negative impact on margins like it did in the December 2006 quarter.

The Applied Materials deal is quite large and the management expects it to be more or less evenly spread every year. Under the deal, Satyam will provide application development, maintenance, support and business transformation services to Applied Materials as a managed service.

Analysts say that over 40 per cent of Satyam's business comes from the enterprise business, which depends on discretionary spends, whereas such long-term contracts are better for tech companies. At its current price, Satyam trades at about 17-18 times FY08 earnings.

With contributions from Anindita Dey and Amriteshwar Mathur