Bold. But Beautiful?

Quite a few companies are commanding triple-digit P/Es even in these turbulent times. Are they really worth it? Ramkrishna Kashelkar explores

EQUITY MARKETS across the globe, including India, have gone into a tailspin following the subprime implosion in the US. The plunge in the Indian stock market has been more or less in line with what is happening everywhere.
    Although the earnings of Indian companies haven't taken a major hit, their valuations have crashed. So, a leading company like Reliance Industries (RIL), which commanded a price-toearnings (P/E) multiple above 30 in January, is now being valued at just nine times its earnings, despite a steady rise in its profits over the past four quarters.
    The P/E multiple is the most widely tracked indicator, reflecting how much premium an investor attaches to a company's trailing earnings or net profits. It also captures the expectations of investors about the company's future growth. Hence, it is but natural that the P/E multiples of most companies have crashed in the current uncertain times.
    But surprisingly, quite a few companies are still commanding triple-digit P/Es. Though a number of BSE 'A' group companies too figure in this list, one wonders if these are instances of high investor confidence or just speculative interest.
    MMTC — a public sector company where the government holds 99.33% of its 5 crore equity shares — has a public shareholding of less than 11,000 equity shares, or 0.02% of the total. For the past one year, the average daily volume in this scrip has been just 541. It is this illiquidity which has enabled the stock to soar beyond what its current fundamentals support. Reliance Natural Resources (RNRL) and Adlabs Films are two companies from the Anil Dhirubhai Ambani group which figure in the list of richly-valued companies.
    RNRL is fighting a court case over the supply of natural gas from RIL and only a win there will help it generate substantial revenues and profits. But excluding this, its existing business model cannot justify the current valuations.
    Adlabs Films had posted healthy profits in FY08, but its numbers in the first half of FY09 are significantly lower due to the amalgamation of its radio business. Although its current market price is just 1.25 times its book value, the return on capital employed (RoCE) has steeply fallen over the past four years and is a major cause for concern for the company.
    Essar Oil commissioned commercial production at its 10.5 million tonne per annum (mtpa) refinery only in May '08. Hence, its earnings for the trailing 12 months appear low, bloating up its P/E multiple. The company has posted a net profit of Rs 56 crore in the first half of FY09.
    The economics of the global refining industry have worsened significantly of late and even if the company is able to repeat this performance in the second half, its current market price will be 90 times its full-year earnings.
    Ispat Industries is highly leveraged, with its debt component being 4.5 times its equity. The company posted a minuscule profit in FY08 after a gap of two years. With interest costs soaring in the September '08 quarter, it again reported a loss. Despite all these factors, the company continues to be one of the favourites among derivatives traders, which has helped the stock remain at high levels.
    There are quite a few companies with net losses in the trailing 12 months which are trading at high prices. Most of them are assetrich companies with high brand value. Since these assets have a certain replacement cost, their market capitalisation is not likely to fall below a certain level, even in difficult times. Some of them are even making healthy cash profits, but high depreciation is pushing them in the red. These include companies such as the three oil marketing companies IndianOil, HPCL and BPCL, Aditya Birla Nuvo, Tata Teleservices Maharashtra and GTL Infra.
    Jet Airways, which was cash positive in FY08 despite a net loss, incurred heavy cash losses in the quarter ended September '08 due to high fuel and operating costs and a weak economic environment. A downturn in textiles and real estate industries hit Bombay Dyeing, which posted losses in three of the four preceding quarters.
    Dozens of companies are trading above P/E of 100 — or even 1,000 in some cases — among the smaller ones. But they continue to remain much more obscure compared to the larger 'A' group companies. Even among these 'A' group companies, we find little justification for such high valuations in most cases.
    However, in some cases, the asset-rich nature of business, positive cash flows and high brand value support the valuations of these companies. Investors should exercise caution while picking up such scrips.
    ramkrishna.kashelkar@timesgroup.com