Where is FII money headed?

The Sensex may be at an all-time high, but it's risen by only 7 per cent this year. This was despite a record inflow of Rs 31600 crore from foreign institutional investors (FIIs) so far this year. Last year, FIIs had pumped Rs 30800 crore into the Indian equity markets, which had led to a 73 per cent jump in the Sensex.

In comparison, this year's tepid performance is intriguing. What's the reason? To start with, there have been a number of big primary and secondary market offerings this year, including ONGC, NTPC and TCS.

FIIs have bought paper worth Rs 10,000 crore (approximately) in newly listed companies and ONGC's secondary offering. With FII interest in mid-caps on the wane (See THE COMPASS dated November 20, 2004), it's reasonable to assume that much of the balance Rs 21600 crore went into large cap stocks.

Sensex stocks also benefited "" FII holding in them rose from around 17.6 per cent at the end of 2003 to over 19 per cent as of September 2004 "" but much of the increase was on account of FII investment in ONGC's secondary offering, which raised their stake in the company from less than one per cent in December 2003 to 6.5 per cent this September.

It seems that a fair amount of FII investment is directed to quality large cap stocks that are outside of the Sensex/Nifty set of stocks they usually look at.

Another reason the high FII investment is not translating into higher levels for the Sensex (unlike last year) is that a host of other investors including mutual funds and individual investors have been booking profits.

In the six months till November, mutual funds have sold equities worth Rs 2,000 crore.

Sensex: then and now

The Sensex may be at the same level as that on January 14, 2004, but its components have charted different territories. 14 stocks have gained since January 14, and barring Bharti Tele-ventures (which was the top performer in both last year and this year's rallies), it's a different set of stocks that have driven this year's performance.

Top of the list are IT stocks, Infosys, Wipro and Satyam, whose market cap has collectively risen 32 per cent since January. While the IT sector has done well this year, valuations now seem too stretched especially given the rupee's sharp appreciation recently.

But outside of IT stocks, the movement in stock prices seems rational. Cement stocks have risen because of an improvement in cement prices, while ITC has risen mainly because of a favourable court ruling in a long-standing case.

Meanwhile, stocks such as ONGC and Hindalco which are highly dependent on commodity prices have corrected (albeit marginally) since their January highs, which is a healthy sign considering that any fall in commodity prices could hit them. Stocks like Dr. Reddy's and HLL, whose performance has fallen considerably, have corrected sharply.

HDFC Bank's ADS : Capital Idea

After ICICI Bank earlier this year, its now HDFC Bank's turn to go the market to raise funds. Unlike ICICI Bank though, HDFC Bank plans to visit only the overseas markets and make an American Depositor Receipt (ADR) issue for an amount of $300mn including a greenshoe option of up to 15 per cent of the amount offered.

The bank 's first ADS offering in July 2001 for $150 million, was priced at $13.83-one ADS representing three underlying shares"" and it now trades at $41. That is a premium of around 25 per cent to the local share which is quoting at around Rs 495.

That explains why the bank prefers to do its fund raising offshore.

Though it might not be able to capture the entire premium, it might well be higher than what it would get locally. In that sense, the timing is great""foreign investors are gushing over India and a premier bank should have little trouble in attracting investments. Significantly, the FII holding in the bank is currently at 47 per cent and this will go up to a majority 51 per cent.

The bank's capital adequacy ratio, currently at 10.9 per cent, will go up to 12.5 per cent and should take care of at least two-three years growth. But the issue should not be dilutive over time, given the 35 per cent plus growth in earnings expected over the next two years propelled by the growth in retail loans and fees.

The strength of the bank's fundamentals is reflected in the fact that it is raising money at a Price/Book of 4X FY05 or at a P/E of almost 15X FY06, assuming the issue will be priced somewhere around these levels. It is the most expensive bank in the Indian universe of bank stocks but that should not deter investors from buying into it.

With contributions from Mobis Philipose and Shobhana Subramanian