No cheap buy

BS Compass

Karnataka Bank's high NPAs weigh on the stock

Karnataka Bank's lack of a promoter group, its professional management and its strong base in Karnataka makes it an obvious takeover target, in a sector in which there are few such targets.

Yet, after a 50 per cent rise in May to Rs 90, the stock fell back and has remained stuck in a trading range since then, although the BSE Bankex has moved up over 30 per cent over the period.

What holds back the Karnataka Bank scrip? At its current price, the stock trades at a substantial discount to its book value.

But that's before the book value is adjusted for the bank's substantial non-performing assets. Net NPAs wipe out almost half its book value. Net NPAs to net advances work out to 7.36 per cent.

Also, non-performing assets do not appear to have peaked "" in FY 2003 Rs 218 crore worth of gross NPAs were added, compared to two-thirds that level a year ago.

Net profit growth last fiscal was 20.8 per cent, but profits owed much to gains on sale of investments. While net profit was Rs 110 crore, profits on sale of investments amounted to Rs 173 crore.

FY 2002 saw a similar situation, with net profit at Rs 91 crore and profits on sale of investments at Rs 179 crore.

Net interest income rose by 10 per cent, but interest expended as a percentage of interest earned is a high 80 per cent. Growth in fee income was very low. The average cost of deposits was a high 8.4 per cent.

The June quarter results show a 70 per cent rise in net profits, but again that's almost entirely due to higher "other income".

In short, Karnataka Bank has several negative features, and the price to be paid for acquisition must reflect these factors. At an adjusted price to book of around 1.1, Karnataka Bank is not cheap.

Steel sector

After a sustained run in steel stocks over the last quarter, they crashed on Tuesday. SAIL was down 15 per cent, Essar Steel 13 per cent, Ispat Industries 7.9 per cent, Bhushan Steel 10 per cent and Tata Steel 3 per cent.

Is it finally time for some stock taking on the steel sector? Fundamentally, there's little reason for a change in outlook.

Steel dealers point out a serious shortage in the commodity, with many of them being unable to get all the quantity they order. Payment too is now on a cash basis, compared to the 75 day letters of credit used earlier.

In short, there's an acute shortage of inventory, and companies are having no trouble selling their products.

Companies are approaching full capacity utilisation, which means that a further rise in demand can only lead to higher prices.

Not only is the current situation a reflection of higher demand from China, but local demand too has been buoyant, as the rising prices of long products bear out.

Further, some of the increase in prices is also a vicious cycle. As the demand for steel grows, so does the demand for raw materials""-iron ore, coke, steel scrap.

Higher raw material prices and their non-availability affects steel production and supply, raising prices.

While a few companies have announced expansion programmes, there will still be a gestation period of around 18-24 months before the additional capacity becomes operational.

According to World Steel Dynamics, there's a 60 per cent probability of steel prices exploding in the near future.

The publication points out that capacity utilisation in the steel industry worldwide is currently 97 per cent, and although production has risen sharply, especially in China, it still won't be able to meet Chinese demand. Japan and CIS demand too has been rising, offsetting declines in North America and Europe.

Constraints on expanding raw material production are expected to result in a mad rush to build up steel inventories before steel prices rise, giving an additional boost to the demand-driven rise in prices.

Of course, any slowing down in Chinese demand due to a piling up of inventory will mean lower prices, as happened some months ago.

But Chinese demand is expected to rise by 35 million tonne this year. In any event, the current signs of shortages in the local market augur well for steel stocks.

With contributions by Sameer Ranade