At best, earnings may grow at a compounded average growth rate of about 20% in fiscal 2009 and fiscal 2010
The price-earnings multiple of the Sensex, the Bombay Stock Exchange’s benchmark index, has dropped from as high as 28.6 times trailing earnings in early January to 18.3 times trailing earnings currently. But, despite this decline by a third, valuations are far from low, especially when viewed in relation to expected earnings growth. Brokerages have trimmed earnings estimates for the current year and the next year on account of rising interest rates and firm commodity prices.
(VALUATIONS ARE STILL NOT LOW)
At best, earnings may grow at a compounded average growth rate of about 20% in fiscal 2009 and fiscal 2010, and if interest rates rise further or commodity prices continue to rule at current levels, even these estimates are at risk.
For the Sensex, the price-earnings to growth, or PEG, ratio may be slightly below 1 at present, but for most of its constituents, current valuations are higher than the estimated growth in earnings for the coming two years. According to data collated by Enam Research, eight of the 12 sectors represented in the Sensex have trailing price-earnings (P-E) multiples that are higher than the estimated growth in the their earnings (see chart). The PEG ratio, which is arrived at by dividing P-E multiple by earnings-per-share growth, is widely used as an indicator of a stock’s potential value.
Some investors use the one-year forward P-E multiple and then compare it with the estimated growth in earnings to arrive at the PEG ratio. But as one fund manager points out, that would be a case of double counting the impact of future growth.
Using the trailing P-E multiple, only the metals and mining, oil and gas, telecom and IT services sectors are valued at a PEG of less than 1. The first two sectors have historically traded at low valuations because their fortunes are linked to commodity prices. In the case of oil and gas, there is the added worry about government intervention in pricing. And for both the telecom and IT sectors, PEG is only slightly lower than 1, and doesn’t really warrant a call for “value- buying”.
The engineering sector, which has the highest estimated earnings growth rate of 26% currently, trades at a valuation of as much as 38 times trailing earnings. For some other sectors such as auto and cement, the price-earnings valuation may look low when seen in isolation, but earnings growth estimates are even lower.
Going by the valuation of the Sensex constituents, there seems to be little upside for the index. What’s more, many Indian firms have adopted aggressive accounting policies in the recent past to buoy reported profit. In some cases, current reported profit may be inflated and hence the P-E multiple may seem lower than they actually are.
Fertilizer stocks: the proof of the pudding...
The Indian government has approved a new policy for the urea sector to tackle the problem of stagnant domestic production and encourage investment by Indian firms. Production from new units and incremental produce through debottlenecking of existing plants are promised higher realizations. Depending on whether the incremental production has come from greenfield or brownfield expansion, or debottlenecking, manufacturers will get 85-95% of import parity price, subject to a price band of $250-425 (Rs10,705-18,199) per tonne.
According to Enam Research, an additional 20% output through debottlenecking can result in a doubling of profit from current levels. Assuming a company goes in for a brownfield expansion and increases capacity by 50% (although this may take about two years to complete), profit could rise by three times. For brownfield expansions, some amount of expense incurred on gas transportation will be reimbursed, making it even more lucrative for firms to consider new investments.
Not surprisingly, fertilizer stocks rose by between 7% and 9% within three days of the policy announcement. Shares of Zuari Industries Ltd jumped by as much as 21% in the same period. But in the next two trading sessions, most fertilizer stocks gave up those gains. Only shares of Zuari have risen meaningfully (15%) since the policy announcement.
Some fertilizer firms seem to be wary about the availability of gas for the new plants. But some analysts believe the supply of gas from the Krishna-Godavari basin will address the gas shortage problem to a large degree.
The fact that the markets have disregarded that possibility and the potential for profits to zoom in the event of any expansion implies that the investors would rather wait and see if these firms actually go ahead with new investment plans.
Another reason for the lacklustre performance of the stocks, of course, is the bearish phase the markets are in currently.
Monday, August 18, 2008
Recession may grip Japan, but China shops hard
Recent data from Japan and the euro zone have reflected a much larger negative impact than initially expected from the deteriorating US housing sector, credit crisis and surging oil prices
Japan’s economy shrank in the second quarter, as a slowdown in demand likely dragged the world’s second largest economy into a recession, but China’s record retail sales in July helped bolster the global outlook.
Japan’s economy contracted 0.6% on a quarterly basis, the fastest since 2001 when it was last in a recession, ending the longest period of uninterrupted growth in six decades and putting the global economy at risk of a prolonged slump.
Recent data from both Japan and the euro zone have reflected a much larger negative impact than initially expected from the deteriorating US housing sector, fallout from the credit crisis and surging oil prices.
As a result, forecasts for higher interest rates to fight price pressures have been pushed back.
Economists are expecting data due later to generally tell the same story of endemic weakness in developed markets. The legion of unemployed Britons claiming benefits in July is expected to spike by the most since 1992, while US retail sales are predicted to have slipped.
“The pullback in the Japanese economy was quite broad, perhaps more broad-based than expected, but the global component is with the trade figures since exports were down quite a bit,” said Jan Lambregts, head of Asia research with Rabobank Global Financial Markets in Hong Kong. “Japan compared with five years ago has a much more diversified set of export destinations, but if all of them are slowing down, there is no real shelter,” he said.
Tokyo’s Nikkei share average tumbled 2.1%, with shares of companies that derive their revenues from both abroad and at home hit hard on fears about much slower global growth. Outside of Japan, stocks in the Asia-Pacific region sank to a 17-month low, according to an MSCI index.
The annnualized contraction of 2.4% in Japan compared with 1.9% growth in the same quarter in the US, where government stimulus supported the economy.
Euro zone second quarter GDP figures are due on Thursday.
Many economists say the Japanese economy is in much better shape than when it went through slumps in 1998 or 2001, with companies having cleaned up their balance sheets after the collapse of an asset bubble in the 1990s.
Japan’s economics minister Kaoru Yosano said the economy was weakening, hurt mainly by external factors such as high oil prices, but added that it won’t keep falling. “Even though the economy contracted in April-June, it would be more accurate to think that it won’t last long,” Yosano said.
A somewhat bright spot in an otherwise blighted global economic scene was non-Japan Asia, where consumers looked forward to an easing in inflation, which has plagued the region’s markets, fomented riots and confounded policymakers.
Retail sales in China, the world’s fastest growing major economy, grew at a record annual rate of 23.3% in July on the back of rising incomes, sparking hopes that Beijing’s efforts to shift to more consumer-driven growth have found some success.
However, China’s flimsy social security system, high labour market turnover and expensive health care and education mean households still save about 30% of their incomes. “The potential for China’s domestic consumption is huge, but it will be a long-term process for China to wean its economy off exports and investment,” said Zhao Qingming, an economist at China Construction Bank in Beijing.
A 23% drop in oil prices since mid-July has also brightened the mood of Australia’s consumers.
Japan’s economy shrank in the second quarter, as a slowdown in demand likely dragged the world’s second largest economy into a recession, but China’s record retail sales in July helped bolster the global outlook.
Japan’s economy contracted 0.6% on a quarterly basis, the fastest since 2001 when it was last in a recession, ending the longest period of uninterrupted growth in six decades and putting the global economy at risk of a prolonged slump.
Recent data from both Japan and the euro zone have reflected a much larger negative impact than initially expected from the deteriorating US housing sector, fallout from the credit crisis and surging oil prices.
As a result, forecasts for higher interest rates to fight price pressures have been pushed back.
Economists are expecting data due later to generally tell the same story of endemic weakness in developed markets. The legion of unemployed Britons claiming benefits in July is expected to spike by the most since 1992, while US retail sales are predicted to have slipped.
“The pullback in the Japanese economy was quite broad, perhaps more broad-based than expected, but the global component is with the trade figures since exports were down quite a bit,” said Jan Lambregts, head of Asia research with Rabobank Global Financial Markets in Hong Kong. “Japan compared with five years ago has a much more diversified set of export destinations, but if all of them are slowing down, there is no real shelter,” he said.
Tokyo’s Nikkei share average tumbled 2.1%, with shares of companies that derive their revenues from both abroad and at home hit hard on fears about much slower global growth. Outside of Japan, stocks in the Asia-Pacific region sank to a 17-month low, according to an MSCI index.
The annnualized contraction of 2.4% in Japan compared with 1.9% growth in the same quarter in the US, where government stimulus supported the economy.
Euro zone second quarter GDP figures are due on Thursday.
Many economists say the Japanese economy is in much better shape than when it went through slumps in 1998 or 2001, with companies having cleaned up their balance sheets after the collapse of an asset bubble in the 1990s.
Japan’s economics minister Kaoru Yosano said the economy was weakening, hurt mainly by external factors such as high oil prices, but added that it won’t keep falling. “Even though the economy contracted in April-June, it would be more accurate to think that it won’t last long,” Yosano said.
A somewhat bright spot in an otherwise blighted global economic scene was non-Japan Asia, where consumers looked forward to an easing in inflation, which has plagued the region’s markets, fomented riots and confounded policymakers.
Retail sales in China, the world’s fastest growing major economy, grew at a record annual rate of 23.3% in July on the back of rising incomes, sparking hopes that Beijing’s efforts to shift to more consumer-driven growth have found some success.
However, China’s flimsy social security system, high labour market turnover and expensive health care and education mean households still save about 30% of their incomes. “The potential for China’s domestic consumption is huge, but it will be a long-term process for China to wean its economy off exports and investment,” said Zhao Qingming, an economist at China Construction Bank in Beijing.
A 23% drop in oil prices since mid-July has also brightened the mood of Australia’s consumers.
The world and oil: it’s deja vu
Consumption responses to high oil prices can be seen across the world. But memories are short.....
It’s a feeling of déjà vu. I was a graduate student in Dallas, Texas, in 1972 when the first oil shock pushed the world into recession. Oil prices later plunged to nearly $10 per barrel, subsequently rocketed to $150 levels, and of late, seem to be retreating again.
The initial oil shock in the early 1970s forced the US economy into recession and also shocked American consumers. A country used to unlimited cheap oil and driving huge oil-guzzling Chevrolets and Cadillacs was not geared for queuing up at gas stations. It was during this period that the Japanese car manufacturers, particularly Honda with its classic Civic with its low gas consumption, started making inroads into the American market.
Overseas, it was not much better. The rest of the world followed the Americans into recession, but adjusted by raising the price of petrol and trying to cut down fuel consumption. They also looked at alternative energy sources. Shale oil and tar sands from Canada held out hope, but the cost of production was still too high to make them economical.
New Zealand was perhaps the most adventurous. One of its “think big” projects was to convert methanol to petrol. In 1979, it decided to go ahead with this. Citicorp arranged the billion dollar financing in 1981 — the largest project financing ever done. A South African firm, Sasol Ltd, perfected the technology to convert coal into petrol (invented in Germany in the 1920s), but because of the country’s racial policies it was not welcomed.
Nuclear technology was initially seen as an alternative. But, the Three Mile Island incident in the US in 1979 and the Chernobyl disaster in the USSR in 1986 stopped new nuclear projects dead in their tracks.
Over the years, with oil production rising, prices crept downward again and several initiatives were abandoned. The Synthetic Fuel Plant was mothballed (it has since been revived in another form) and the enthusiasm for shale oil and tar sands died as the cost of production was too high.
Brazil was perhaps the only country which made a determined effort to find alternatives. With its vast farm lands, sugar cane-based ethanol helped reduce its dependence on oil imports.
Japan is probably the only developed economy that made energy conservation a national goal and its industry found new ways to limit its oil consumption. It limited its annual energy usage to a billion barrels after the 1970s. A decade ago, its companies restructured to be competitive at $4 per gallon oil. It is probably the most successful among the Organisation for Economic Co-operation and Development countries in becoming more energy-efficient through initiatives such as low-emission cars, rooftop gardens, energy-efficient air conditioners and refrigerators, “intelligent machines” from subway fare chargers to building escalators that automatically turn off when not in use, and using plastic pellets from recycled plastic as fuel in their steel mills. It is now looking at selling this technology to other countries.
The supply-demand situation is now quite different from the 1970s and the 1980s, when the US, Japan and Europe were the dominant consumers. Now, the US, China, Russia, Japan, Germany and India account for almost 53% of global consumption. On the supply front, Russia and some Commonwealth of Independent States are beginning to be players in the energy market. Along with them, some African countries such as Angola, Sudan, and gas producers such as Qatar and the United Arab Emirates are stepping up production as well.
For the last 12-24 months, the situation has been paradoxical. It was only when oil touched almost $150 a barrel that the economies started tumbling and the tipping point was the housing market collapse in the US. Until then, the world economy, particularly emerging markets, grew at record rates. There was no incentive for oil producers to reduce prices.
The upside is that other initiatives that were abandoned because of their economics are now being taken up. Oil extraction from shale and tar sands is becoming viable, with Canada as the largest player. Coal-to-petrol plants, with Sasol’s technology, are being set up in Germany, West Asia and the US. Nuclear energy is no longer feared. Other energy alternatives such as wind, hydroelectric, ethanol from sugar cane, corn and other sources are also being actively pursued.
Closer home, Asian markets, including India and China, continue to maintain their growth, albeit at a slower pace. In the US, the sale of the gas guzzlers and sport-utility vehicles has almost stopped, making the already difficult restructuring of the US auto industry even tougher. Tata Motors is on both sides of the fence. Its recent acquisitions of Jaguar and Land Rover are bound to be impacted, but the Tata Nano and the company’s skills and technology in making low-cost cars are drawing attention from car manufacturers globally. Other industries in India should learn from Japan and make minimizing energy usage a top priority.
Unfortunately, people have short memories. If oil prices go back to the $60-80 per barrel levels (which in my opinion is possible within the next 12 months), then the world will go back to its old habits until the next crisis.
It’s a feeling of déjà vu. I was a graduate student in Dallas, Texas, in 1972 when the first oil shock pushed the world into recession. Oil prices later plunged to nearly $10 per barrel, subsequently rocketed to $150 levels, and of late, seem to be retreating again.
The initial oil shock in the early 1970s forced the US economy into recession and also shocked American consumers. A country used to unlimited cheap oil and driving huge oil-guzzling Chevrolets and Cadillacs was not geared for queuing up at gas stations. It was during this period that the Japanese car manufacturers, particularly Honda with its classic Civic with its low gas consumption, started making inroads into the American market.
Overseas, it was not much better. The rest of the world followed the Americans into recession, but adjusted by raising the price of petrol and trying to cut down fuel consumption. They also looked at alternative energy sources. Shale oil and tar sands from Canada held out hope, but the cost of production was still too high to make them economical.
New Zealand was perhaps the most adventurous. One of its “think big” projects was to convert methanol to petrol. In 1979, it decided to go ahead with this. Citicorp arranged the billion dollar financing in 1981 — the largest project financing ever done. A South African firm, Sasol Ltd, perfected the technology to convert coal into petrol (invented in Germany in the 1920s), but because of the country’s racial policies it was not welcomed.
Nuclear technology was initially seen as an alternative. But, the Three Mile Island incident in the US in 1979 and the Chernobyl disaster in the USSR in 1986 stopped new nuclear projects dead in their tracks.
Over the years, with oil production rising, prices crept downward again and several initiatives were abandoned. The Synthetic Fuel Plant was mothballed (it has since been revived in another form) and the enthusiasm for shale oil and tar sands died as the cost of production was too high.
Brazil was perhaps the only country which made a determined effort to find alternatives. With its vast farm lands, sugar cane-based ethanol helped reduce its dependence on oil imports.
Japan is probably the only developed economy that made energy conservation a national goal and its industry found new ways to limit its oil consumption. It limited its annual energy usage to a billion barrels after the 1970s. A decade ago, its companies restructured to be competitive at $4 per gallon oil. It is probably the most successful among the Organisation for Economic Co-operation and Development countries in becoming more energy-efficient through initiatives such as low-emission cars, rooftop gardens, energy-efficient air conditioners and refrigerators, “intelligent machines” from subway fare chargers to building escalators that automatically turn off when not in use, and using plastic pellets from recycled plastic as fuel in their steel mills. It is now looking at selling this technology to other countries.
The supply-demand situation is now quite different from the 1970s and the 1980s, when the US, Japan and Europe were the dominant consumers. Now, the US, China, Russia, Japan, Germany and India account for almost 53% of global consumption. On the supply front, Russia and some Commonwealth of Independent States are beginning to be players in the energy market. Along with them, some African countries such as Angola, Sudan, and gas producers such as Qatar and the United Arab Emirates are stepping up production as well.
For the last 12-24 months, the situation has been paradoxical. It was only when oil touched almost $150 a barrel that the economies started tumbling and the tipping point was the housing market collapse in the US. Until then, the world economy, particularly emerging markets, grew at record rates. There was no incentive for oil producers to reduce prices.
The upside is that other initiatives that were abandoned because of their economics are now being taken up. Oil extraction from shale and tar sands is becoming viable, with Canada as the largest player. Coal-to-petrol plants, with Sasol’s technology, are being set up in Germany, West Asia and the US. Nuclear energy is no longer feared. Other energy alternatives such as wind, hydroelectric, ethanol from sugar cane, corn and other sources are also being actively pursued.
Closer home, Asian markets, including India and China, continue to maintain their growth, albeit at a slower pace. In the US, the sale of the gas guzzlers and sport-utility vehicles has almost stopped, making the already difficult restructuring of the US auto industry even tougher. Tata Motors is on both sides of the fence. Its recent acquisitions of Jaguar and Land Rover are bound to be impacted, but the Tata Nano and the company’s skills and technology in making low-cost cars are drawing attention from car manufacturers globally. Other industries in India should learn from Japan and make minimizing energy usage a top priority.
Unfortunately, people have short memories. If oil prices go back to the $60-80 per barrel levels (which in my opinion is possible within the next 12 months), then the world will go back to its old habits until the next crisis.
Subscribe to:
Posts (Atom)