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The Euro Link

Rahul Oberoi/Money Today | Print Edition: October 2012

Have you been tracking developments in the Eurozone? Maybe not, as it may seem too distant a place and the events there too intricate to hold your interest. However, you may be among millions of stock investors whose fortunes are linked to what happens in the European Union, which includes the crisis-hit Eurozone.

Consider this: During the first week of August, the European Central Bank unveiled its unlimited bondbuying plan in an attempt to tackle the region's debt woes. After the announcement, both domestic and global markets reacted positively. The Sensex jumped 337 points to 17,683 on September 7 while Dow Jones, S&P 500 and CAC rose 1.9 per cent, 2 per cent and 3 per cent, respectively

On September 12, the domestic equity market again rose after a German court rejected complaints against the European Stability Mechanism. That day, the Sensex crossed the 18,000 mark for the first time since 14 March 2012.

There are more than 23 companies in the BSE 500 index which get 20 per cent or more revenue from the European market . The list is diverse and includes big names such as Tata Steel, Tech Mahindra, Suzlon, Divi's Lab, Tata Motors, Crisil, Infosys and Sintex Industries. The list has been compiled with the help of data provider ACE Equity and annual reports of companies.

For instance, 55 per cent of Tata Steel's revenue comes from the European market. The figure is 47 per cent for Tech Mahindra, 38 per cent for Suzlon, 34 per cent for Divi's Lab, 32 per cent for Dr Reddy's Lab, 25 per cent for TCS and 23 per cent for Tata Motors.

Does this worry you? If you own any of these stocks, it should, as further escalation of the crisis in the region may impact these companies which, in turn, will reflect on their stocks.

Should the situation improve if leaders of the Eurozone reach an agreement on bailing out the stressed countries, the investors may gain.

CRISIS ZONE

The region is facing a sovereign debt crisis with a few countries facing difficulty in servicing debt. Fears of default have led credit rating agencies to downgrade many economies in the region.

The Eurozone comprises 17 out of 27 European Union countries, including France, Germany, Italy, Spain and the Netherlands. However, some European Union countries, such as the United Kingdom, Poland and Denmark, use their own currencies.

According to Wikipedia, in 2011 the European Union's combined gross domestic product, or GDP, was $17.57 trillion, 20 per cent of global GDP. The combined nominal GDP of the Eurozone at the end of 2011 was $13.11 trillion compared to US' $15.09 trillion.

The 27 European Union countries account for around 18 per cent of India's exports, with the largest share taken by software, engineering, textiles, gems & jewellery and pharmaceutical sectors.

Dipen Shah, head of PCG (Private Client Group) Research, Kotak Securities, says, "The valuation of stocks which have exposure to the EU has contracted. One should be careful while dealing in such stocks."

THE BIG ONES

Tata Steel:

Tata Steel generated 55 per cent revenue from Europe in 2011-12. According to the company's annual report for 2011-12, the operations in Europe will continue to be under stress for a year or two until the Western European economies recover.

Sales in Europe remained flat at 3.5 million tonnes per quarter. Fourth-quarter average revenue per tonne was 9 per cent less than in the first quarter.

Tata Steel's expansion will depend on its ability to generate cash and attract fresh equity and loans. The debt taken to buy Corus in 2007, which resides in Tata Steel Europe's balance sheet, is a risk.

In September 2010, Pound 3.6 billion ($5.9 billion at the September 6 exchange rate) senior secured loans arranged for the acquisition were refinanced with new senior secured facilities comprising Pound 3.4 billion ($5.4 billion) term loans and a Pound 0.69 billion ($1 billion) revolving credit facility to provide working capital for Tata Steel Europe.

Bhavesh Chauhan, research analyst, metals & mining, oil & gas, Angel Broking, says, "Corus was acquired when the steel cycle was at its best. Since the acquisition, it has turned for the worse. There has been demand collapse in developed countries after the Lehman crisis, leading to overcapacity. Without captive iron ore or coking coal and with high staff costs, the company's plants are uncompetitive and hence continue to make losses at the bottom-line level. The sovereign debt crisis in Europe seems the final nail in the coffin."

On August 27, the price-to-earning ratio (P/E) of Tata Steel was 6.42 compared to the industry average of 9.76. A high P/E suggests that investors are expecting higher earnings growth in the future for which they are willing to pay a premium.

"At current levels, we believe the risk-reward ratio is favourable. The stock can touch Rs 481 during the next one year," says Chauhan. It was at Rs 350 on September 5.

Suzlon Energy:

The global wind power company is the world's fifth-largest wind turbine maker according to installed capacity. Suzlon earns more than 40 per cent revenue from Europe, thanks largely to its purchase of Germany's REpower.

"The crisis in the region is affecting the company. With the region's economies showing no sign of revival, the going will get tough for the company," says DK Aggarwal, chairman and managing director, SMC Investments and Advisor.

The company has been incurring losses since 2009-10 on account of high interest payments and falling sales. It made net losses of Rs 473 crore, Rs 1,317 crore and Rs 990 crore, respectively, in the last three financial years.

The immediate challenge is $209 million foreign currency convertible bonds (FCCBs) that are becoming due in October this year. The company hopes to meet the obligation through sale of non-core assets through which it expects to raise $100-200 million (Rs 550-1,100 crore).

The company also plans to reduce fixed costs by 20 per cent. Its order book is worth Rs 39,700 crore. The consolidated debt-to-equity ratio is 1.50.

The stock touched an all-time low of Rs 14 on August 28. Since August 2011, it has fallen over 60 per cent and is trading at a price-to-book value of 0.55.

Infosys:

Europe accounts for over 21 per cent revenue of Infosys. During the April-June period, the business Europe fell about 8 per cent. The company has said that it will gradually reduce its dependence on the region.

Nidhi Sarswat, senior research analyst, Bonanza Portfolio, says, "We think if the company comes out with a strategy, its positive outcome may be seen in the coming quarters." Infosys' main financial services business, too, failed to impress.

During the April-June period, the company posted a consolidated net profit of Rs 2,289 crore, down 1.16 per cent from Rs 2,316 crore in the January-March quarter.

Foreign institutional investors reduced their holding in the company from 22.40 crore shares in March 2012 to 21.75 crore shares in June 2012. The stock has fallen over 15 per cent since the start of the financial year. It was at Rs 2,423 on 28 August.

Sarswat says, "We do not expect any major price gain in 2012-13. The stock can touch Rs 2,650 on the upper side. It has strong support at Rs 2,150 and thereafter at Rs 2,100."

Tata Motors:

The acquisition of Jaguar Land Rover enabled the company to enter the premium car market in developed markets such as the UK, the US and Europe as well as in growing markets such as China and Russia. Tata Motors generated over 22 per cent revenue from the European Union countries in 2011-12.

According to the company's annual report, in 2011-12, it sold 68,420 units of Jaguar Land Rover brands, a 27.4 per cent increase from 2010-11.

The management says the demand for medium and heavy commercial vehicles and passenger vehicles will remain subdued for some time due to tough macroeconomic conditions while the light commercial vehicle segment will show strong growth.

In the first quarter of 2012-13, Tata Motors reported consolidated top line of Rs 44,176 crore, up 30 per cent, from Rs 34,061 crore in the corresponding quarter a year ago. The bottom line jumped to Rs 2,314 crore from Rs 1,994 crore in the corresponding quarter a year ago.

A report by Shah Investor's Home, a brokerage house, in August said Jaguar Land Rover continued strong growth in the first quarter due to launch of Range Rover Evoque and Jaguar XF 2.2L models, with the high-margin China region contributing 22 per cent to sales.

However, margins shrunk due to money spent on promoting Evoque and higher staff costs. The brokerage has increased its 12-month target for the stock from Rs 270 to Rs 277. On August 28, it was at Rs 237 with a price-to-earning, or PE, ratio of 16.30 compared to the industry average of 18.17. PE is the valuation ratio of a company's current share price compared to its pershare earnings.

Divi's Laboratories:

Exports accounted for 89 per cent gross sales of the company in 2011-12 as against 92 per cent in 2010-11. Out of the total, it generated 28 per cent revenue from Europe as against 29.8 per cent in 2010-11. It posted a consolidated net profit of Rs 533 crore, up 24 per cent from Rs 429 crore in 2010-11.

VK Vijayakumar, investment strategist, Geojit BNP Paribas Financial Services, says, "Issues in Europe are not likely to impact India's exports in a big way. The pharmaceutical sector will do well even though the environment is not very favourable."

The company is targeting fresh capex of Rs 150-200 crore in 2012-13. It has already spent Rs 450 crore under this head in the past two years, which reflects the confidence of the management about the future.

Nimish Desai, pharma analyst, Motilal Oswal Financial Services, says, "We expect Divi's Laboratories to be a key beneficiary of increased outsourcing from India given its strong relationship with global innovator pharmaceutical companies. The stock is trading at 21.8 times 2012-13 expected earnings and 18 times 2013-14 expected earnings and can touch Rs 1,250 during the next few quarters."

This year, till August 30, the stock has risen over 45 per cent and is trading around Rs 1,151.

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