Crashing Against Rate Barrier

Following the seventh round of benchmark rate hikes in 2010-11, stocks of rate-sensitive sectors - banking, auto and realty - have seen fall in prices.

Rahul Oberoi/Money Today        Print Edition: March 2011

The Reserve Bank of India's (RBI) seventh round of hike in policy rates this financial year spooked stock markets as foreign institutional investors (FIIs) beat a hasty retreat, triggering off all-round selling. But the worst hit, predictably were interest rate-sensitive stocks-banking, auto and realty. While some analysts see a further downturn in these stocks in the short-term, others find the valuations attractive at the current levels.

"Ambiguity among market participants still exists about the quantum of future rate increases and whether the RBI will be able to contain inflation to its newly revised target of 7%. Rate-sensitive stocks will continue to exhibit volatility until there is a clear indication that inflation is under control," says Samir Gilani, head of equities at MAPE Securities.

The RBI, on January 25, raised the repurchase (repo) rate, or the rate at which banks borrow from the central bank and the reverse-repo rate (the rate at which the RBI borrows from banks) by 25 basis points (bps) each. A hundred basis points make up 1%. Since March last year, the RBI has hiked repo, currently 6.5%, and reverse repo, currently 5.5%, by 175 bps and 225 bps respectively. Despite the rate hikes, the banking regulator revised its inflation projection for March 2011 to 7% from its previous estimate of 5.5% Banking stocks, which gave a return of 45% (going by the BSE Bankex) between January 2010 and October 2010, have fallen by more than 12% on an average since November last year.

"The profitability of banks is likely to get impacted as hardening of yields is likely to exert pressure on the treasury portfolios of banks. With incremental deposit growth lagging behind credit growth, banks are likely to hike deposit rates from current level. Net interest margins are also likely to come under pressure," says Kunal Bothra, manager, retail advisory and technical analyst, LKP Securities.

It is no surprise then that banking majors SBI, ICICI Bank HDFC Bank and Axis Bank have corrected by between 22% and 33% from their 52-week highs since November. However, Samir Gilani differs with Bothra on the future of banking shares, seeing value in some of the stocks at current levels. He believes that well-run banks will be able to maintain and grow their net interest margins (NIMs) with an expected deposit growth rate of between 15% and 18% and credit growth at 18%, over the next few quarters.

However, ground reality does not look too optimistic. Between November 2010 and January 2011, index heavyweight, such as HDFC Bank, Bank of India, Union Bank of India and Punjab National Bank retreated 12.31%, 12.58%, 16.32% and 16.51%, respectively. The auto story is not looking sanguine either. Auto majors, such as Mahindra & Mahindra (M&M) and Maruti Suzuki, have corrected by between 10% and 42% from their 52-week highs in anticipation of reduced volume growth. M&M lost around 15% and Maruti Suzuki tumbled 23%. Between November 2010 to January 2011, Tata Motors, M&M and Bharat Forge retreated 2%, 9% and 9%, respectively, as the BSE Auto Index fell by over 11% (see Index Performance).

Vaishali Jajoo, automobile analyst with Angel Broking says, "Increased input costs and interest rates are the anticipated headwinds that could affect the sector's volume and earnings growth in the near term, as a result of which the stocks are looking weak since November 2010. We expect rising input costs to restrict profitability, despite having a positive view on demand." However, Jajoo remains positive on the long-term prospects of the domestic automobile sector.

Angel Broking prefers stocks with attractive valuations where strong fundamentals could deliver positive earning surprises, such as Maruti Suzuki and M&M. Neither has everybody has completely written off auto stocks in the short-term. "Passenger cars and bikes are less vulnerable to interest rate hikes as compared to commercial vehicles. Passenger vehicles will see healthy volumes in this year with some compromise on the bottom line due to higher raw material costs," says Gilani. Since November last year, news about rate hikes has been falling like a ton of bricks on the real estate sector.

12% is the fall in returns by banking stocks since Novermber 2010, according to BSE Bankex

11% is the fall in returns by BSE Auto Index as Tata and M&M retreated 2% and 9%, respectively
Among the BSE sectoral indices, the BSE Realty Index has tumbled the most in the last three months. The index lost 12% in November, 17% in December and 8% in January (Index Performance). Realty heavyweight, DLF, Unitech, Indiabulls Real Estate and Housing Development and Infrastructure Ltd have lost 39%, 52%, 51% and 51% respectively, since November.

Subsequent rate hikes are expected to hurt the realty sector the most. "The concern with realty stocks is more to do with volumes, pricing and debt concerns and ability to finance working capital needs, and further cost increases in financing will limit their ability," according to Gilani of MAPE Securities.

There is no denying the fact that rate-sensitive sectors will have to bear the pain of inflation and rate hikes, but Kunal Bothra strikes an upbeat note, "The long-term growth story is still holding up, however over the short term the stocks will most likely bear the brunt…We continue to be bullish on the long-term growth story and the role of the banking sector."

Report Card - Third Quarter
For the quarter ended 31 December 2010, the banking sector has posted better results as compared with ratesensitive auto and realty sectors. The banking sector has posted a rise of 33% in profit after tax (PAT) figures against the corresponding quarter a year ago. Average PAT figures of auto and realty sector increased by only 16% and 25% respectively.

Among banking majors, ICICI Bank posted a net profit of Rs 1,437.02 crore, up 30.51%, against Rs 1,101.06 crore in the corresponding quarter last year. PAT of HDFC Bank, State Bank of India and Axis Bank went up by 32.91% to Rs 1,087.83 crore, 14.08% (Rs 2,828.06) and 35.88% (Rs 891.36).

"Rate-sensitive stocks will continue to be volatile until there is a clear indication that inflation is under control."
Samir Gilani
Head (Equities), MAPE Securities

"Over the short term these (rate-sensitive) stocks will most likely bear the brunt (of inflation and rate hikes)."
Kunal Bothra
Manager, Retail Advisory and Technical Analyst, LKP Securities
The Society of Indian Automobile Manufacturers expects the growth in domestic automobile industry to be lower in 2011-12 compared with 2010-11 due to the base effect. According to Motilal Oswal Financial Services, the auto industry is likely to face multiple headwinds in the short-run due to increase in cost of ownership as selling price increased due to partial pass-through of cost inflation in raw materials and increase in cost of operations as fuel prices increased by approximately 15-22% in last 1 year. However, the long-term volume outlook is positive due to improved economic activity, easy availability of finance and improved export outlook.

Auto major M&M posted a net profit of Rs 734.68 crore, up 77.59%, for the quarter ended 30 December 2010. However, Maruti Suzuki saw a 17.80% decline in profit to Rs 565.17 crore against Rs 687.53 crore in the corresponding quarter last year. Some analysts also believe that the growth of domestic automobile industry will depend on the purchasing power of the consumer.

Pankaj Pandey, head of research at ICICI Direct says, "In terms of results, banking came out with a very good set of numbers. In fact, we were expecting some pressure on spreads, which were not visible in this quarter (January-March). However, there are worries about pressure on spreads because the cost of fund is likely to go up, which is prevalent in the auto sector. Cost of raw material, such as rubber and aluminium, is rising and it could hurt auto companies."

In the real estate sector, DLF showed a net profit of Rs 204.82 crore, down 9.92%, in the third quarter against Rs 227.38 crore in the corresponding quarter last year. However, Indiabulls Real Estate registered a net profit of Rs 19.53 crore, up 300.64%, against Rs 4.87 crore a year ago. "Real Estate is going through a phase of tight liquidity. The sector requires liquidity at individual and developer levels. The cost of fund is increasing, which is not good for the realty sector. On capital intensive sectors we are not expecting great set of fourth quarter numbers," Pandey added.

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