No longer iffy about pricing

BS Compass

Infosys' second quarter is backed up by better offshore volumes and billing

Before Infosys dropped its guidance bomb in April, its stock got a discounting of 22 times estimated FY04 earnings. According to consensus estimates then, Infy's earnings would grow over 30 per cent, which meant a PEG of 0.7.

Currently, on a lower earnings growth estimate, the stock gets a forward PE of over 25 times, and a PEG of almost 1. The main reason for this has to be put down to the improvement in "market sentiment".

Infosys's volume growth of 8 per cent in the September quarter is the lowest in about six quarters, which is surprising especially given the heavy recruitment done by IT companies in the last quarter.

The saving grace was that much work moved offshore - offshore volumes grew 10.8 per cent. Besides, average pricing was higher by about 1.5 per cent over the June quarter and these two factors led to a 120 basis points jump in gross margins.

The company also says that its average pricing next year (i.e. after the yearly re-negotiations) would not be lower compared to 2003. This is a huge positive because most estimates for FY05 factor in a decline in billing rates.

But this may be negated if the rupee continues to rise against the dollar. Every one per cent appreciation in the rupee has a 0.5 per cent impact on the EBITDA, although forward bookings mitigate that impact to some extent.

The upward revision in the guidance was more or less on expected lines, and the revised EPS is now in line with consensus estimates. Net recruitment numbers, as expected were strong at 2181 employees.

Moreover, the company plans to add another 3000 employees in the next six months, which simply means that the visibility in the terms of volumes has improved.

Even the outlook on pricing is better. While, at a PEG of 1, these factors seem well priced in, the runaway improvement in "market sentiment" could change all that.

Irrational expectations

Whoever said that any and every stock is a multi-bagger in a bull run must be a laughing all the way to the bank. That is precisely what is happening in the stock markets nowadays.

Most of the biggest gainers in the markets since January 1 have been penny stocks with no significant revenues and profits to speak of nor any meaningful change in profits to warrant the bullishness in their stock prices.

For instance, the stock price of Polychem has gone through the stratosphere with an appreciation of 2189 per cent from Rs 1.4 to Rs 34.

Do the fundamentals justify this change? Over the last two quarters (March 2003 and June 2003), its topline fell 75 per cent (compared to March quarter last year) and posted a near 100 per cent decline in the June quarter but its net profits during the same periods improved 105 per cent and 39 per cent. The BSE site listed only an "other income" of Rs 25 lakhs as income for the June quarter.

Similarly, Shalimar Agro Products' stock has jumped 1819 per cent since January. Fundamentally, while sales rose 600 per cent and 900 per cent in the March 2003 and June 2003 quarters, its net profits fell 81 per cent and rose 233 per cent during the respective periods. Suryadeep Salt Refinery is another stock that has risen 894 per cent.

While its topline fell 8 per cent in the March quarter, neither the BSE nor the NSE have any record of its results for the June quarter. Bhansali Engineering is another penny stock whose price has jumped from Rs 8 in January to Rs 118 currently.

Its performance is the stuff that makes for a financial thriller. While the March quarter witnessed a leap in net profits 154 per cent, the June quarter saw profits take a dive of 164 per cent.

The list of such rags to riches stocks is endless and investing such low priced stocks appears extremely enticing to the average investor. Given the volatility in the financial performances of such companies, the stock prices are clearly not driven by fundamentals but more by sentiment.

With contributions from Mobis Philipose and Sameer Ranade