Voltas - Cooling effect

A recovery in demand and robust order book augur well for Voltas.

Synonymous with air-conditioning, Voltas once again proved its mettle in the electro-mechanical project business when it bagged two larger orders worth Rs 300 crore pertaining to the Chennai and Kolkata airports. This comes immediately on the back of a good set of results declared on May 29. These events have led to the stock rising 35 per cent as against the BSE Sensex’s four per cent gain since then. For those who think they might have missed the bus, don’t lose hope as there is scope to make healthy returns in the long-run.

Larger than perception
Many people view Voltas as an air conditioning (AC) company. Yes, it is a dominant player in the commercial and residential AC segment, but there’s a lot more to it. Post it’s restructuring in 2003, Voltas increased its focus on the engineering segment to emerge as a niche player in the electro-mechanical projects (MEP) and services business. This segment includes complete turnkey solutions for work related to central air-conditioning (airports, malls, offices, etc), refrigeration and solutions for water treatment and management.

The move helped Voltas de-risk its revenues as well as reduce its dependence on the low margin business, where stiff competition and seasonality were among concerns. It has also helped the company reach higher scale and tap upcoming opportunities in the projects business, where profit margins are relatively better.

The recently won orders worth Rs 300 crore for electro-mechanical work at the Kolkata and Chennai international airports is in addition to similar orders won in the past. For instance, while Voltas completed the project for the new Hyderabad international airport last year, it has completed similar projects for the world's largest passenger terminus of Hong Kong International Airport as well as the Mumbai airport. Going by the various estimates, the opportunities in this segment is huge as the government is also planning to invest in over 30 new non-metro airports besides, modernising existing airports of the country.

There are equally large long-term opportunities in segments like metro railways (stations), shopping malls, hospitals, hotels, education institutes, corporate buildings, high rise towers, multiplexes and cold storage. The company has already has a successful track record of having executed several projects in these segments. However, over the last one year, analysts were worried about the slowdown in these segments and the impact of high raw material prices on the company’s profit margins. But, the MEP segment, which accounted for 62 per cent of total sales, reported a revenue growth of 53.7 per cent year-on-year for 2008-09. This can be attributed to the company’s strong order book position. For now, the worries haven’t vanished totally and some concerns still exists, which pertain to the slowdown in the international operations (contributes 60 per cent to the project business); largely the gulf countries. For instance, during 2008-09, there was a 40 per cent contraction in flow of new orders from international markets, which analysts attributed to slow down in capital expenditure, particularly by crude oil producing countries due to lower oil prices.

In comfort zone
But, given the company’s current order book of Rs 4,700 crore, the same is good enough for the company to maintain a revenue growth at about 20 per cent this year. And, for the next year and beyond, if the recent improvement in the economic environment is sustained (including the rise in crude oil prices, which have crossed to $70 per barrel), then expect Voltas’ order book to swell further. Notably, the management, too, has guided for robust order inflows from countries like Qatar, Abu Dhabi and Saudi Arabia. In the domestic front, recovery in the industrial capex and near-term impetus provided by the government stimulus packages could further add to the kitty.

Equipment business
Additionally, the economic recovery will also augur well for the company’s engineering products business (13.4 per cent of total revenues), which primarily includes manufacture and distribution of equipments for materials handling, mining and construction and textiles industries. Here too, the company is among the leading domestic players. However, this segment reported a two per cent decline in revenue in 2008-09 as against nearly 30 per cent growth in the past few years. This business also reported significant erosion in operating profit margins, from 20.5 per cent in 2007-08 to 11.6 per cent in 2008-09. While a meaningful recovery could take another 2-3 quarters, analysts believe that the company’s move to cut down its inventory levels coupled with the recovery in industrial activity and winning of an Rs 210 crore order for mining equipment from Hindustan Zinc, are all good signs. Nevertheless, the segment holds good long-term prospects.

SOOTHING NUMBERS
in Rs crore	FY09	FY10E	FY11E
Revenue	4,033	5,100	6,100
EBIDTA	294	383	464
EBIDTA (%)	7.3	7.5	7.6
Net profit	228.0	270.0	329.0
EPS (Rs)	6.9	8.2	10.0
PE (x)	19.1	16.1	13.2
E: analyst estimates

Evolving opportunities
Meanwhile, the company’s second largest revenue contributor (22.5 per cent of sales) is the unitary cooling systems division, which includes residential and commercial ACs, commercial refrigeration and water coolers. This business is expected to report stable 10-12 per cent revenue growth on a sustainable basis. During 2008-09, revenues grew by 11.3 per cent, while operating profit margins were up at 7.4 per cent, albeit marginally. Although this is a highly competitive segment, the company is among the leading players (second in AC segment). In light of the rising income levels of individuals, increasing affordability, higher availability of electricity and demand from the commercial office and retail segments, the long-term prospects of this business too are good.

Outlook
The company operates in three growing segments, where the penetration levels are still low in India compared to some of the international markets. Its leadership in these segments and increasing focus on expansion into foreign markets should help it sustain healthy growth. Attributes like consistent revenue track record, regular dividend payments and negligible capex needs put the stock in better light. At Rs 133, the stock trades at 16 times and 13 times its estimated 2009-10 and 2010-11 earnings.

ITC - Fairly valued

Despite decent growth rates estimated for this fiscal, there is limited upside to the ITC stock.

For a large part of 2008 and until March 2009, the stock of ITC outperformed the broader markets, thanks to its defensive attributes including steady financial performance and strong cash flows that find favour during uncertain market conditions. But, at current valuations as well as considering some recent developments, it makes one wonder whether the stock will continue to deliver outperforming returns. While among recent events are the company’s March 2009 quarter performance, which was somewhat subdued, and the hike in value-added tax (VAT) by the Maharashtra government, the stock’s current valuation (PE of 19.4 times estimated 2009-10 earnings) is also not cheap.

Recent concerns?
Last week, the Maharashtra government recommended a hike in the VAT rate on cigarettes from 12.5 per cent to 20 per cent. While analysts estimate that Maharashtra accounts for about 10 per cent of ITC’s cigarette sales (in value terms) and a small price hike across key brands could offset the proposed hike in VAT, they fear that similar moves by other state governments (or a significant hike in the forthcoming Union Budget) could force ITC and other players to raise prices. “Thus, it poses a threat to ITC’s cigarette volumes in 2009-10,” Sharekhan’s analyst said in a note.

While the fears could well prove unfounded, the past data indicates that price hikes have a strong impact on volume growth (See chart). Any sharp increase in prices negatively impacts volume growth—a moderate price hike can still support healthy volume growth. Even in the last two fiscal years, when the tax on cigarette was hiked by 30 per cent (2007-08 Union Budget) and excise duty on non-filter cigarettes was hiked between 140-390 per cent (2008-09), it has had an impact on ITC’s cigarette volumes.

For ITC though, it has a fairly robust track record in the business, which enjoys a domestic market share of over 75 per cent. The company has been consistently investing in its business through use of technology, product innovation, marketing, and has strong brands. While these have helped it in passing on any cost increases to consumers, they have also helped in overcoming extra-ordinary times. For instance, after the hike in duty on non-filter cigarettes last year, ITC discontinued sales of such products and through various measures was able to upgrade a majority of customers to the higher priced filter cigarettes.

This along with select price increases helped its cigarette revenues to grow by 13.9 per cent to Rs 7,557 crore and profits by 15.1 per cent to Rs 4,184 crore in 2008-09, even as volumes are estimated to have declined by 3-4 per cent.

However, says an analyst, “going by history, ITC’s stock valuations are largely linked to the growth in its cigarette volumes. The sentiments get impacted as the government tries to curb the category and that impacts the PE.”

Hoping that there won’t be any major negative surprises, and assuming (at worst) a moderate hike in taxes, analysts are expecting ITC to clock volume growth of 4-5 per cent in the cigarette business in 2009-10. This is comparable to the average growth in the last five years and suggests that the company should continue to generate strong cash flows to pay dividends as well as nurture other businesses.

Non-tobacco FMCG
Most of these businesses, like packaged foods, apparels and personal care, have strong growth potential. But, in the last two quarters (Q3 and Q4 of 2008-09), growth rates have slowed down to 10-15 per cent year-on-year as compared to 28-30 per cent in Q1 and Q2 of 2008-09 and 45-50 per cent quarterly growth in 2007-08.

While the economic slowdown could be partly responsible, in the branded packaged foods business the company has been focussing on consolidating its portfolio in select high margin categories.

The branded apparels sales were also impacted, especially the mid-segment brand ‘John Players’. Here too, ITC is taking various measures (closing unviable stories, renegotiating rentals) to improve productivity.

Going ahead, while the company continues to invest towards scaling up these businesses, analysts expect the focus on profitability to result in the segment’s losses reducing by about 20 per cent in 2009-10.

Also, given the high base (sales of Rs 3,000 crore), sustaining high growth rates may not be possible and hence, they are projecting sales to rise by 15 per cent in 2009-10.

Others
Among other key contributors, the agri and paper and packaging businesses have shown an improvement in profitability. Last year, the company completed the expansion of capacities of pulp and paperboard leading to better sales growth and profitability in the latter half, which is expected to sustain in the current year as well.

In the agri business, while revenues were flat in 2008-09, it was largely due to a 51 per cent fall in sales (led by lower soya volumes and rationalisation of the commodity portfolio) in the March 2009 quarter. Notably, profit margins improved due to better realisations in the leaf tobacco business; profits thus nearly doubled to Rs 256 crore in 2008-09. While analysts don’t expect sales growth to be high in this business, margins are likely to be sustained in 2009-10.

The weak economic environment and terror strikes in Mumbai last year impacted the industry’s fortunes and, ITC too reported a decline in sales and profits. The current year however, may find some cushion from commissioning of new capacities. Nevertheless, hotels contributed less than 7 per cent to profits in last year.

Outlook
Overall, the key growth drivers for ITC in 2009-10 are seen as the cigarette, non-tobacco FMCG and paper businesses. Analysts expect the company’s total sales to grow by 14-15 per cent and profits by 16-18 per cent over the next two years.

While the longer-term prospects look decent given the investments ITC is making in growth potential non-tobacco FMCG businesses among others, at Rs 197, the stock trades at 19.4 times the estimated 2009-10 earnings (and 16.7 times 2010-11 EPS), which is not cheap and is also not far from its fair value (based on a sum of parts valuation) of Rs 206 per share, as estimated by analysts.

Investing amid conflicting signals

Rely on your instincts and don't worry about others.

The sudden sharp U-turn of equity markets in the past 10-odd days have given a lot of investors the feeling that they have been left out along with the Left. At the same time, the scars of the past are haunting people who consider re-entering the market now. The Sensex levels of 7,000 and 8,000 have been deeply etched in every equity investor's mind and those who want to invest are sitting on the sidelines just to enter at lower levels. Yet, even perennial bears and global hedge fund managers are now saying there might not be much downside from the current levels of 14,000.

At the same time, gold has been flat for almost a couple of months and has been slightly inching upwards. Real estate is showing no signs of revival, but builders believe things will suddenly improve because of the change of guard at the Centre. Interest rates, not just on loans but also on fixed deposits, have gone down. While all this is happening, oil has gone up to $65 from a low of $34 just a few months earlier. Higher oil prices could result in higher inflation in the future, which could mean interest rates firming up. Recently though, some banks announced that interest rates would be cut by around 1.5% in the near future. Hence, there are many conflicting signals and the key question is what one must do now.

EQUITY
There is no way one can invest at the lowest level of the markets and then get out at the highest level. The strategy must be to buy lower and sell higher. Don't worry about what others are doing. A lot of money is lost waiting for corrections to come and, hence, one must look at investing in a staggered manner. Invest on every dip and also through systematic investments.

This is also the time to weed stocks and funds with poor fundamentals and move into solid companies that are available at extremely low valuations.

If you have made good profits in the past couple of months, book and use these to pay off your loans or reduce your liabilities. Market analysts now think the budget, monsoon direction and Q1 earnings could be the next trigger. There could be a couple more no one knows of today which could surprise the markets. A correction is certainly on the cards, but no one knows when that will happen. Do not wait for the markets to go back to 8,000 but start deploying on every major dip.

GOLD
Though I am very bullish on gold, I believe you must book some profits if you have sizeable exposure to it. Sure, gold can go up from here, but the immediate upside looks capped. In equity market parlance ,we might be somewhere near 18,500-19,000 Sensex levels. Gold, being a volatile asset class, can correct by as high as 10 per cent in a day and don't be surprised to see days of Rs 1,000 falls in gold prices. Over the next two-three years, gold could shine. But, book profits regularly; this is certainly a time to do so.

REAL ESTATE
Builders, of late, have been sounding off bullish tones with the revival of equity markets, QIPs and other alternative sources of funding. However, prices have not corrected enough to spur demand in residential real estate. Interest rates, one of the levers of real estate demand, has clearly gone down and will be mouth-watering a couple of weeks down the line. An even bigger lever, price, which has a huge impact on affordability, must go down by at least 25 per cent for genuine demand to come back in the market.

Don't believe the noise of 'last few flats left' or that people have started buying again. It is only the speculators who are trying to prop up the markets, whereas smart real estate investors are still trying to exit.

DEBT
Keep short-term money in fixed deposits (people in the lower tax brackets), Liquid Plus and Floating Rate Funds. Short Term Bond Funds are also good options from a six to nine month perspective and can deliver around 8 per cent returns. If you have a time horizon of a year, you can still look at Income Plans (Long Term Bond Funds) that could much deliver much better returns. A caveat here is that the government borrowing programme could keep bond yields higher, which might result in negative returns from such bond funds.

The Indian political landscape has changed profoundly in positive ways for the next five years. Implementation of reforms is paramount for success of the high expectations markets have from the change of guard. The key is to understand the changes happening around you and be ready to profit from it.

Contrasting styles of investment

Value averaging may give better returns compared to sips, but it is complex for retail investors.

onventional wisdom: To get the best return from stock markets, buy when prices are low and sell when they appreciate. But for the common investor, it’s rarely possible, as the stock market does not travel just one way.

To protect returns from the mercurial markets, investors are conventionally advised to invest regularly through a systematic investment plan (SIP). The benefit of an SIP is straight; it averages out the cost of purchase by buying at different levels, thanks to the regular investment. This is also called rupee cost averaging.

Of late, many investors have shifted away from this strategy. This is apparent from the fact that new mutual fund products that book profits regularly have been an instant hit. If you compared SIP returns with lumpsum investment in the current rally, the latter has fared better. Even if you compare the past three-year data, you will see a majority of funds have yielded the same result. The fact, though, is that an SIP fares better over a longer period. Though, it cannot beat lumpsum investment if someone invests at the bottom of the market, which then keeps going up.

For investors who rate value buying above investing a fixed amount every month, there is an alternative strategy. It is called value averaging. This is a more evolved strategy than rupee cost averaging, or SIP. In this, you adjust or vary the amount invested to meet a prescribed target value of the portfolio.

SIP, on the other hand, is a strategy in which you invest a fixed rupee amount on a regular basis, usually monthly purchase of shares or units of mutual funds. When the share or your mutual fund's value falls, you buy slightly more shares or units of the fund for the fixed investment amount, and slightly fewer when the price goes up. In this manner, the investor lowers the average purchase cost. But in value averaging, the investor invests more when prices fall and less, or nil, when it gains.

VALUE AVERAGING AND FINANCIAL GOALS

Using this mechanism, a person can build his financial goal and be sure of attaining it, irrespective of returns from the market. Here’s how it’s done: rather than trying to attain a fixed monthly amount, the investor could fix a compounded annual target growth of his portfolio. So, if you want your portfolio to grow by 15 per cent year-on-year, you contribute in such a manner as to reach this percentage each month.

An example should make this clear. For starters, in the value averaging concept, the investor needs to set a target rate of growth of their portfolio.

That is, with a target rate of growth of portfolio of 15 per cent, you are planning to create a Rs 6 lakh corpus in 10 ten years for say, a car or initial down payment for a house in 10 years.

In the first month, you invest Rs 5,000. However, because the market has fallen by say, 10 per cent, your investment is worth Rs 4,500 at the end of month 1.

Whereas, given the pre-defined rate of growth, your investment should have been worth Rs 5,750. So in month 2, you will have to invest Rs 6,250. Similarly, if the market had gone up by say, 20 per cent (Rs 6,000) the investment required in month 2 would have been only Rs 4,750.

Similarly, over time, depending on the rate of return that has been pre-decided, the targeted sum can be achieved.

VALUE AVERAGING AND RUPEE AVERAGING

In most of the research conducted worldwide, value averaging has always fared better than investments through SIP, though marginally.

Benchmark Mutual Fund, that has an index fund wherein an investor may opt for the value averaging technique, has done research comparing returns from the two investing methods. For SIP, they studied what a fixed amount of Rs 2,000 would yield if invested in the S&P CNX 500 index. For value averaging, the mutual fund started with Rs 2,000 and kept the upper limit of investment to Rs 20,000. The portfolio growth was targeted at 15 per cent each year over 15 years. The result: the latter delivered 2.87 per cent more returns each year.

WHERE SIP SCORES

The main goal of value averaging is to acquire more shares when prices are falling and fewer shares when prices are rising. This happens in rupee cost averaging as well, but the effect is less pronounced, although both will closely resemble market returns over the same period.

The biggest potential pitfall with value averaging is that as an investor's asset base grows, the ability to fund shortfalls can become too large to keep up with. Many investors may not have the potential for funding this shortfall as they save for multiple goals at the same time.

One way around this problem is to allocate a portion of money in a liquid fund and rotate the money when markets fall. But this can have tax implications. Also, when you invest as per market conditions, experts believe the investor is indirectly timing the market.

SIP, on the other hand, is neutral to timing the market. The investor is aware of the monthly outgo and does not need to keep a track of market movements.

CONCLUSION

Value averaging, if done by the investor himself, has some glitches. This method is for investors who can manage unpredictable cash flows. This is because the amount of investment varies with the market condition.

Another financial expert says there is more risk in this mode of investing. "When you put in more money on market corrections, you are exposed more to equities, making this riskier," he said. It will do much better in a rising market, as the portfolio will have few problems in achieving the targeted growth.

To actually benefit from the method, a person will need to regularly invest over a long tenure, of at least eight-nine years. “Here, the person will complete an entire bull-and-bear cycle, to average the value of his purchase,” said an investment adviser.

FIIs favouring India; will keep investing: ICICI Sec

"Market should sustain its growth momentum. The FII (foreign institutional investment) liquidity will also continue... We have a large number of FII clients and they all are very bullish about Indian market," she told PTI in a telephonic interview.

Buch noted that about 90 global funds, at a conference hosted by I-Sec in March, had said that "even if markets went down, their India allocation would be intact".

"That was the time when things were not so rosy for the stock market and there was a level of uncertainty among the investors... Despite that the funds were bullish about India," she added.

The MD and CEO of the country's top equity brokerage house said that in less than two and half months of the current fiscal, FIIs have already pumped in $6.3 billion — which is more than half of the total outflow of about $11 billion in the previous fiscal 2008-09.

"Going forward, I would say that we see continuation of FII inflow over the next 3-6 months," she said.

"The pace (of FII inflow) could slow down a bit, as the recent weeks have seen a sudden inflow of funds that had accumulated during a prolonged period of uncertainty in the run up to the elections and due to other factors," Buch said, while adding that the inflows would still continue over the coming months.

"This shows the confidence in the India growth story. It's about an across-the-board growth in our economy, spanning across all the demographics and all income-levels," she added.

"Most definitely, India would be one of the biggest destinations for FIIs. We have an added advantage of a stable financial system and regulatory framework, which have been demonstrated again by the policy makers and regulators in the recent past... Swift handling of cases like Satyam has also added to the credibility," she said.

Supported by huge FII inflow, the stock market has grown nearly 90 per cent in the past three months, thus nearly doubling the investors' wealth.

The market benchmark Sensex has surged past the 15,000- points level during this time to hit its highest level in nearly one year, thus recouping a large chunk of losses suffered since the beginning of a downward journey in January last year in tandem with a global downturn.

Asked if I-Sec was ready for the growth that was coming into its business with the market revival, Buch said, "The answer will be a resounding yes. Besides, we were confident about the revival of the upward momentum and we were ready for this." "Market was very slow in 2008-09, still we managed a net profit of Rs 520 crore and moreover our market share grew during the year, which is a big achievement. Then, we did not have to do any layoffs, like many others," Buch said.

Buch, who was appointed I-Sec Chief in February, said that she has completed more than 100 days in the office and things have changed considerably during this period.

"At the time of joining, people were asking whether it was a good decision to shift from banking business to market segment, given the state of condition of the markets at that time. But just a few weeks later, things started changing and those questions have stopped," she said.

"Besides, I-Sec has grown into a very, very important part of ICICI group. Many might not believe that market participants are actually important for the overall economy, but we do play an important role," Buch added.

Basics: When the time is right

Signals to look for before deciding when to enter, lie low or get out of stock markets.

Cautious Bull, Optimistic Bull, Fearful Bear are some of the terms thrown at equity investors in the past several weeks. Most investors are waiting on the sidelines, mulling whether to enter the market or not. Some question if this rally is sustainable. Remember two things. One, there is no way for anyone to predict what the markets can do in the next few days. Two, and a key point:equity markets recover much before the actual economy does. There are no easy answers but, yes, there are certain signals one should look at.

FII FLOWS
Let's start with this, an easy one for most people. India is a very shallow equity market and in global market parlance, is like a village when compared to developed equity markets where there is a lot of participation, not just from institutional investors but also from retail investors, through retirement and education plans. The point is that Indian markets are highly dependent on flows from foreign institutional investors (FIIs).A few billion dollars have the propensity to take the market in either direction. Hence, FII inflows and outflows must be tracked carefully to see if delivery-based buying has been taking place consistently. If markets move up consistently on rising volumes and increasing FII flows, it's a signal that buying interest has come back and its time to scale up equity exposure. Of course, it is important to take stock of valuations but these can remain stretched for an extended period of time.

CREDIT SITUATION
Then there is credit, the lifeline of any economy. It's important that companies and individuals have access to credit at reasonable rates. High inflation is followed by higher interest rates and this often has a dent on corporate and consumer balance sheets. At the same time, if banks are unwilling to lend, the short-term outcome will not be rosy. On the other hand, low inflation, low interest rates and easy credit flow are good signs for corporations and individuals. When this happens, take a look at the loans disbursed by banks and financial institutions. The question to ask is, have banks started to lend and are corporations and individuals borrowing? A healthy credit situation and easy liquidity situation, beside good future corporate performance, also means equity markets could see decent inflows and less outflows.

GENERAL SENTIMENT/ CONSUMER SPENDING
This is, again, an important signal a lay person can see if around him. Are people buying homes , cars, taking vacations , buying electronic items, queuing at restaurants and so on? If you see most of these things happening around you, it means people have disposable income and access to credit. If this is so, corporate profits are likely to improve or increase in the future. Also ask yourself: "Are people more optimistic about the future now than they were six months before? What about businesses? Have they started hiring again?" Recruitment activity picking up is again a very important signal and one to be watched closely. Though there is no employment or unemployment data that is released in India every month, talking to people from different sectors and companies could give you a good indication. Look within your own firm or business. Has the business scenario changed for the better or worse?

IMPROVEMENT IN MACRO NUMBERS
That means corporate earnings, inflation, GDP growth, agriculture output, IIP numbers, export numbers, oil prices -- being some of the macro numbers one should look at. Their interpretation should be viewed in the context of what has happened in the immediate past and whether there are any improvements in these numbers. Most analysts were expecting a GDP growth of below 5 per cent last year, but this prediction was short-lived, as the numbers were a strong 6.3 per cent. If in one of the worst years the economy has the potential to grow at 6.3, does it mean we could grow at much higher rates if the economic and investment environment were favourable?. There are several such questions to review on every parameter. At the same time , do not overanalyse, as it may lead to inaction.

EQUITY MARKET MOVES
Then again, are equity market moves more broad-based across sectors or restricted to one or a few sectors? During the technology boom of 1999 and the power sector boom of 2007, any company that had technology and power written on it would go up by leaps and bounds, defying logic and common sense. At the same time, there are times when the market moves are broader-based, like the ones we saw during a substantial part of the bull run. If the market moves are broad in nature and mid-caps also start to catch up, then there is a strong likelihood that a much stronger upward move will happen in the future.

Finally, remember two cardinal rules. Do not put any short-term money, required in the next one to two years, in equity. Second, the best time to invest is when the markets stink, so ignore the noise around you and invest if you get to do so between PEs of 8 to 12 of the market. Rational and courageous investors who did buy between October 2008 and March 2009 are now laughing all their way to the bank.

Jargons in stock market analysis

Like everything else in life, stock prices are driven by supply and demand. Supply is synonymous with bears and selling. Demand is synonymous with bulls and buying. As demand increases, prices advance and when supply increases, prices decline. When supply and demand are equal, bulls and bears slug it out for control.

WHERE IS SUPPORT ESTABLISHED?
As the price declines, buyers become more inclined to buy and sellers less inclined to sell. A point where demand overcomes supply and prevents the price from falling becomes a support.

Human behaviour is responsible for existence of supports and resistance. Many investors who have zeroed in on a particular stock may not commit their resources as prices are falling. Once the price starts rising, they rue the fact that they did not buy it when it was low and vow to buy it if prices come back to those levels. If buying demand overcomes supply at those levels, prices will rise from that level again, reinforcing the psychology. Significance of the support level increases, the more times the price bounces back from that level.

Support does not always hold and a break below support signals that the supply from bears has won over the demand form bulls. A decline below support indicates a new willingness to sell and a lack of willingness to buy. Once support is broken, another support level will have to be established at a lower level. Sometimes price movements can be volatile and an intra-day dip below support is not considered a breach of support, which we call a 'whipsaw'.

WHAT IS RESISTANCE?
As the price advances, sellers become more inclined to sell and buyers are wary of committing resources at high levels. At a point where supply exceeds demand and prices stop rising, further movement is resisted. Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further.

As the price falls from such a resistance point, investors who were hoping for a further rise now realise they have missed on selling the stock. And when prices rise to this resistance level, they remember to sell this time, which creates pressure from all such investors who were left holding the baby earlier. This makes the resistance point a tough nut to crack.

The significance of the resistance level increases with the number of times the price reverses from that level. Just like support, Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell.

SUPPORT EQUALS RESISTANCE
Once the price breaks the support and travels lower, it turns into a resistance. Similarly, if the price pierces the resistance and goes further up, the resistance level then becomes the support. A mere intraday violation of the support and resistance levels is not enough. It should close above the resistance or close below the support to qualify as a successful breach.

The previous day's, week's or month's low are common examples of support. Similarly, the previous day's, week's or month's high acts as a resistance. Round figures like 40, 100, etc also act as general resistances. The issue price of a stock also acts as a support or resistance for IPO listings.

If a stock reaches a support level, it pays to give attention to a sign of increased demand and for a potential reversal, similarly look for signs of extra supply at resistance levels. If a support or resistance level is broken, it signals the relationship between supply and demand has changed and one can initiate a trade in that direction with that level as a 'stop loss'.

Asian Paints - A strong finish

The decline in housing loan rates, focus on affordable housing, cut in excise duty on paints as well as on automobiles and the emphasis on infrastructure should help Asian Paints sustain decent growth rates. The relatively lower input costs are also helping the Rs 13,500 crore paint industry, two-thirds of which is controlled by the organised segment.

Asian Paints is the largest domestic player with a market share of around 43-45 per cent in the organised sphere, about twice as large as its nearest competitor.

COLOURFUL PALETTE
in Rs crore	FY 09A	FY 10E	FY11E
Net sales	5,463.0	5,950.0	6,702.0
Operating profit	669.0	776.0	884.0
Adj net profit	401.0	467.0	538.0
EPS (Rs)	41.8	49.0	58.0
PE (x)	26.5	22.6	19.1
E: analyst estimates

Although the sharp slowdown seen in end-2008 also impacted Asian Paints, the company’s March 2009 quarter performance is reflecting visible signs of recovery and provides comfort.

The company’s Rs 400 crore expansion programme is also on track for commissioning in April 2010, which will result in a 35-40 per cent increase in its domestic production capacity. This should help it capture any recovery in demand in the medium-term.

Decorative: Looking better
If experts are to be believed, the worst (for the economy) is behind us, and even though growth rates may not look up in a hurry, the current scenario should hold on. For Asian Paints, its sales volumes which were impacted in the December 2008 quarter were up by 12-13 per cent in March 2009 quarter.

A combination of factors helped including strong demand in tier I and II cities, marriage season in March quarter and increased stocking by the trade post de-stocking in the December 2008 quarter.

Analysts now expect the company to clock 10-12 per cent volume growth in 2009-10, led by the improving environment and Asian Paints stronghold in the business.

The company has a strong brand portfolio, which along with a presence at various price points would help reach to diverse pockets in the decorative space. Popular brands include “Tractor” in the lower-end paint range (distemper), “Royale play” in emulsions, “Utsav” in enamels in the interior walls space.

Apart from leadership in interior walls space, the company has been focusing on external paints with brands like “Ace” and “Apex” and has emerged as the market leader in the external segment. Apart from its wide product range, access to distribution network of over 25,000 retail outlets ensures greater visibility for its products.

The other respite for the company has come in the form of lower costs. The paints sector uses around 300 raw materials (around 50 per cent crude-based derivatives) in the manufacturing process. The rapid fall in crude oil prices (and the rupee’s appreciation) have reduced pressure on the raw material front.

Besides raw materials, the announcement of duty cuts in December 2008 has meant that excise duty on paints has come down from 14 per cent to 10 per cent. These events have allowed paint players like Asian paints to pass on some gains (price cuts) to customers. Nonetheless, margins are likely to improve to 13.5-14.0 per cent levels seen in the past (excluding 2008-09).

Beyond domestic borders
International operations add around 17 per cent to consolidated revenues with regions like Middle-East contributing substantially. The Middle-East region along with emerging markets of South- Asia has been the major growth drivers, each growing at above 35 per cent. Superior growth rates in these regions helped international operations to grow at 28 per cent in 2008-09 as compared to 12 per cent growth seen in 2007-08.

As the slowdown is sparing none, the resultant fall in crude prices was also anticipated to impact demand in the Middle-East markets. Analysts believe that even as there could be some short-term pressures (in some markets), the longer-term potential is huge in these markets and Middle-East should continue to drive the company’s international sales.

Meanwhile, Asian Paints is setting up a new plant in Egypt, which is perhaps some indication of the future. Overall, the company’s focused initiatives like product introductions, dealer tinting systems and also increasing operating efficiency would boost growth rates in the future.

Financials: Enviable
Barring short-term blips like the one seen in 2008, Asian Paints’ performance has been good with consolidated sales and net profits growing by 19 per cent and 30 per cent, respectively on an average in the last five years.

Apart from positive cash flows for each of the last ten years, the company has also been generating high returns on the capital employed in its business (over 50 per cent in the last four years). These have helped it to payout an average 50 per cent of its net profit as dividend to its shareholders, which is high given that only a few Indian companies do so.

With the domestic economy showing signs of stability (expectations of an improvement from second half of 2009-10), the company should report decent growth in volumes. But, as realisations may not keep pace (due to price cuts), the sales growth is seen at 9-10 per cent in 2009-10. However, with prices of inputs lower, margins should improve helping the company report a profit growth of 15-18 per cent.

Outlook
The average sales volume growth in the industry has a high correlation to the general economic activity, thus earlier high GDP rates has helped decorative as well industrial paints segments do well. With the economic outlook seen improving, the growth pressures should also subside.

On the other hand, given India’s low per capita consumption of paint of around 750 grams; about half of China’s and much lower compared to developed market (15-20 kg), experts suggest that the demand should remain healthy in the long-run as well.

The improving demographics and income levels, rising individual aspirations and planned investments in industrial and infrastructure capex are some macro factors that will provide a fillip to demand for paints. The prospect in other global markets where Asian Paints operates is also reasonably decent. Thus, expect the company to gain in the years to come.

Meanwhile, analysts expect the company to clock 16-18 per cent annual growth in profits over 2009-10 and 2010-11. At Rs 1,108 the stock is trading at 19 times its estimated 2010-11 earnings. While it appears relatively expensive as compared to the BSE Sensex, it has commanded a healthy premium over the latter. Investors with a long-term perspective can consider the stock on dips.

Mid-caps trading at attractive valuations

In the third and final series of interviews in Smart Portfolios, Kashyap Pujara, fund manager, Enam Direct, shares his current investment strategy, view on mid-caps, small-caps and his advice to investors with Rex Cano. Since the launch of Smart Portfolios on September 1, 2008, the benchmark BSE 200 networth, is now down a little over a per cent, while Kashyap Pujara's portfolio value has appreciated over 22 per cent till date. How has your strategy changed after the sharp rally? Actually, the rally witnessed is largely an outcome of the election results which has led to improvement in investor confidence and expectations of economic recovery. The change in strategy reflects the changed political landscape. The reason is that we could now see reforms being implemented which were earlier met with resistance. A stronger political landscape has ensured greater commitment of funds to equities. KASHYAP PUJARA Fund Manager, ENAM Direct Top Holdings % of assets Cost (Rs) Price Current price (Rs) Value (Rs lakh) Reliance Capital 15.04 855.03 919.00 1.84 SBI 14.11 1,434.69 1,724.35 1.72 Century Textiles 12.90 273.35 394.00 1.58 Aditya Birla Nuvo 10.91 634.36 889.15 1.33 Oriental Bk of Com 7.42 165.43 181.25 0.91 Total investments 91.33 11.16 Cash 8.67 1.06 Net worth 12.22 Returns (%) 22.22 What's good for investments now? Sectors where reforms can happen should be watched. These include insurance, telecom, education and banking. There would be thrust on infrastructure and power which needs investment and hence one can look at this space as well. How should one approach mid-caps and small-caps? This is a potential area to scout for investments. The future value of any investment is dependent on the price we end up paying to acquire it. If we end up paying higher, the future returns would be lower. To put things in perspective, there are yet lot of mid- and small-cap companies that are available at attractive valuations and hence it does make sense to invest bottom up. Though stocks are up considerably from their all time lows, they are yet available at close to book value which can deliver above 20-25 per cent return on equity. If one can gauge the management quality, the consistent performance and sustainability of returns, then such companies could trade at higher multiples to book value in the future. Are we in a bull or bear market? Bull and bear markets are typically a reflection of economic cycles that play out on an ongoing basis. There is an expansion cycle that typically ends with a business peak followed by contractions which typically ends with a recessionary trough. In general, due to greater integration of the world economy we have seen longer expansion cycles and shorter recession cycles. The developed world might yet be going through the contraction cycle which we term as bear market, however, emerging markets especially India, seems to have made a recessionary trough. Leading indicators like cement and auto sales are reflecting this to some extent. Hence my sense is that the worst is behind us and we would turn going forward. However, please bear in mind that the markets discount the future before it has actually panned out and hence we end up seeing higher valuations at bottom of the cycles and cheaper valuations at the tops. How should investors tackle the current market situation? The secret to successful investing is within each investor. As an investor, if you are a critical thinker who evaluates his investment decisions meticulously, invests with conviction, displays patience and defines a time horizon, then one can build a good investment portfolio over the longer term. The markets tend to oscillate between extreme pessimism to extreme optimism. As investors, we need to attempt to be realistic and not let other people's mood swings govern or affect our portfolio decisions. As veteran, Ben Graham has said, in the end, how your investments behave is much less important than how you behave. Hence for starters, define your return expectations, your risk appetite and risk taking ability, as ability to take risk and capacity to take risk differ, and hence set your expectations of return and risk accordingly. Define a time horizon and diversify appropriately so as to eliminate the unsystematic risk from your portfolios. AMAR AMBANI Vice President (Research), India Infoline Top Holdings % of assets Cost (Rs) Price Current price (Rs) Value (Rs lakh) Indiabulls Real 12.37 217.85 198.85 1.67 Reliance Capital 4.08 971.25 919.00 0.55 IDFC 3.93 140.00 132.65 0.53 Texmaco 3.87 110.45 104.45 0.52 IDBI Bank 3.79 108.50 107.65 0.51 Total investments 62.32 8.42 Cash 37.68 5.09 Net worth 13.51 Returns (%) 35.08 SADANAND SHETTY Vice President, Kotak Securities Top Holdings % of assets Cost (Rs) Price Current price (Rs) Value (Rs lakh) McLeod Russel 5.74 100.31 110.15 0.72 GVK Power & Infr 5.35 36.30 40.30 0.68 Reliance Capital 5.03 829.35 919.00 0.63 Shriram Trans 5.00 230.10 287.00 0.63 ICICI Bank 4.98 684.57 713.75 0.63 Total investments 85.10 10.74 Cash 14.90 1.88 Net worth 12.62 Returns (%) 26.16 ANAND AGARWAL Fund Manager, Reliance Money Top Holdings % of assets Cost (Rs) Price Current price (Rs) Value (Rs lakh) Opto Circuits 8.79 159.20 161.70 1.29 Colgate 7.44 560.36 547.20 1.09 ITC 6.78 184.4 199.70 1.00 Infosys 6.02 1725.00 1771.10 0.89 TCS 5.17 368.25 380.85 0.76 Total investments 69.02 10.16 Cash 30.98 4.56 Net worth 14.72 Returns (%) 47.19