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Indices at new highs during the week as Reliance announce de-merger details

Rex Mathew*
6 August 2005


The week once again belonged to Reliance as the company formally announced the de-merger plan after market hours on Friday. The week started on a volatile note on Monday as the markets fluctuated considerably. The sensex managed to cross the 7700 mark briefly in intra-day trades before losing ground and closing below that mark.

Strong rally in Reliance and PSU oil stocks saw the markets surge on Tuesday and the sensex closed above the 7700 mark comfortably. Expectations about a formal announcement about the de-merger at the Reliance Industries AGM kept the markets excited and the company crossed Rs1 lakh crore in market capitalisation. Reliance is the first private company and the second after ONGC among all companies to achieve this feat.

The company's AGM on Wednesday was a rather tame affair with Mukesh Ambani holding stage with huge investment plans for the company's refinery. The disappointment led to a sell-off in Reliance Industries and the indices closed the day on a flat note.

Anil Ambani provided the excitement for Thursday by announcing the de-merger details after market hours on the previous day. The Sensex promptly went past the 7800 mark, but closed marginally lower on weakness in technology and banking stocks. All round buying was seen in engineering stocks.

Friday turned out to be a day of profit booking though significant buying was seen in metals and select power stocks. The indices closed lower following the weakness in technology and banking stocks.

After the underperformance during previous week, mid-caps bounced back and surged to record levels during the week. Except on Wednesday when it closed on a flat note, the CNX Mid-Cap 100 index managed to close with strong gains through out the week. The index closed the week on Friday at a new lifetime high.

Domestic economic and regulatory action

  • There are reports that the government is planning to issue oil bonds to the PSU oil marketing companies to compensate them for the subsidies on petroleum products. The oil bonds would transfer the cost of subsidies from the companies to the exchequer, rightly so since subsidies are decided by the political leadership.

    However, there is a high probability that the proposal would not be implemented given the precarious financial position of the government. Now that it has been formally decided to suspend the disinvestment programme, the government would have to find adequate resources to meet the demands of the employment guarantee programme and similar welfare schemes.

    The report of a parliamentary committee on oil product pricing would put further pressure on the government. It has recommended a reduction in the various duties imposed on petroleum products so as to keep the prices at retail level low. The committee has also recommended an abolition of export subsidies on petroleum products.

    The committee report throws further light to the strange ways of duties on petroleum products. Successive governments have viewed this as an area of easy taxation, which generates plentiful cash flows to the government kitty. The report points out that the government has collected over Rs55,000 crore as cess on petroleum products for the development of energy sector ever since such a duty was imposed. Of this, not even Rs1,000 crore was given to the PSU oil companies!

  • Inflation for the week ended 23 July declined to 4.07 per cent from 4.18 per cent for the previous week. The decline was attributed to a fall in prices of food articles while the price level of manufactured goods remained steady.

Industry update

  • After more than three years of fast paced growth, the automobile industry is showing signs of a marginal slow down this year. Volume growth in most segments has come down to single digits as the industry is finding it difficult to build on the large base.

    Despite the slow down in volume growth, profitability of frontline auto companies was hardly affected during the first quarter. This was surprising given the fact that input costs, especially steel prices, have gone up substantially as compared to last year. The industry was able to maintain margins by rationalising costs and keeping average unit realisations steady.

  • The expansion of the auto ancillary industry has helped the automakers in rationalising costs and improving quality. The significant export opportunities that have opened up during the last few years have enabled the frontline ancillary companies to build capacities and bring down unit costs. They have also improved quality significantly by entering into technological alliances with overseas companies.

    The auto ancillary industry is in a position to reap significant rewards in future if they can maintain their thrust on technological and quality improvement. The steady growth in the domestic auto market has enabled many of the homegrown companies to achieve better economies of scale, even though most of them remain tiny by global standards. The global auto majors have brought some of their own suppliers to the country which has helped increase the competition and thereby improve the competencies of domestic ancillary companies.

    The country has significant resources in terms of technically qualified workforce, design capabilities, availability of material inputs etc to make it big in the global market for auto components. Many of the large global auto parts manufacturers are shifting their base to lower cost locations and India is emerging as one of the better choices of them.

    Domestic ancillary companies are also expanding their geographical reach by acquiring companies in Europe and US. The acquisitions are tiny by US and European standards and have not attracted much attention in those countries. However, these are significant initial steps for the Indian companies in their quest to acquire technology and product development skills. More importantly, these acquisitions give the Indian companies access to these large markets.

Corporate Moves

  • The details of the de-merger of the Reliance group into the Reliance Industries group and the Anil Ambani group were formally announced after the board meeting of Reliance Industries yesterday. The announcement has come after months of speculation in the stock markets and media about the way the empire would be split between the two brothers.

    The de-merger as announced would happen in two2 stages. In the first stage four holding companies would be formed under the names Reliance Energy Ventures, Reliance Capital Ventures, Reliance Communication Ventures and Global Fuel Management. Reliance Industries' holdings in Reliance Energy and Reliance Capital would be transferred to Reliance Energy Ventures and Reliance Capital Ventures.

    Reliance Communication Ventures would receive the current holdings of Reliance Industries in the telecom ventures Reliance Infocomm, Reliance Telecom (GSM operator in the eastern states) and Reliance Communication Infrastructure. Global Fuel Management would hold natural gas supply contracts from Reliance Industries, which would feed the thermal generation plants of Reliance Energy in future.

    Reliance Industries shareholders would get one share each in all the four holding companies for every share held by them. All these holding companies would be listed on the exchanges. Energy Ventures and Capital Ventures would have a capital base of Rs1,223 crore each while Communication Ventures and Global Fuel Management would have equity capital of Rs611 crore each.

    Reliance Industries' shareholders would hold 5 shares of Reliance Capital and 7 shares of Reliance Energy indirectly through Reliance Capital Ventures and Reliance Energy Ventures respectively. Reliance Communication Ventures would hold approximately 66 per cent of Reliance Infocomm and 35 per cent of Reliance Telecom.

    In the second stage, Reliance Energy Ventures and Reliance Capital Ventures would be merged into Reliance Energy and Reliance Capital respectively. The Anil Ambani group would then have four listed companies Reliance Communication Ventures, Reliance Energy, Reliance Capital and Global Fuel Management.

  • The announcement of de-merger details was another opportunity for the group to display their version of transparency and corporate governance. Much to the disappointment of stock market traders and media, Reliance Industries did not announce the details of the de-merger at its AGM and stated that a team of financial and legal consultants are preparing the details.

    As if to steal the media exposure, Anil Ambani wasted no time and held a press conference within hours of the conclusion of the AGM and gave out all the details of the de-merger. How can a significant shareholder and one of the interested parties disclose such details when the board of directors of Reliance Industries, which is the decision making body at least in paper, had stated that the details are being worked out? Interestingly, the Reliance board of directors disowned the Anil Ambani statements the very next day though the de-merger details approved by it later were more or less in line with what the younger brother had announced.

    Anil Ambani later thanked the board of directors of Reliance Industries for accepting 'his proposals' for de-merger in the interests of transparency and fairness. Was it really a case of Anil Ambani proposing and the board accepting it? If so, what was the need for independent valuations by legal and financial consultants?

    If this is the high standard of corporate governance and transparency Anil Ambani is professing, then the group has a long way to go even to meet the standards of some of the other Indian corporate groups. As usual, the market regulator SEBI remains a silent spectator.

US markets, economy and oil

The US indices closed on a weak note on the last day for the second week in a row, but unlike the previous week the frontline indices declined during this week. The Dow lost close to a per cent during the week while losses on the NASDAQ and S&P 500 were lower.

Ironically, strong economic growth was the leading factor behind the decline followed by surging crude prices. Continuing growth in US economy has led most analysts to forecast higher interest rates.

Job additions in US for the month of July was stronger than expected and unemployment rate at 5 per cent is at a four-year low. Growth in income and consumer spending for last month came out to be better than expectations. Consumer credit for the month of June increased by over $14 billion, which again was higher than expected.

Healthy labour markets and strong growth in consumer spending is keeping US economic growth buoyant. Some economists have hiked their US economic growth projections for the July-September quarter to 4.5 per cent and even 5 per cent annualised. The US economy had expanded 3.4 per cent during the April-June quarter.

The acceleration in economic growth has pushed bond yields to a 4 month high on expectations that the US Fed would continue to increase rates in the foreseeable future. Most analysts have revised upwards their Fed interest rate forecast to between 4 and 4.5 per cent by the year-end or by first quarter of next year.

Crude prices continued their rally from the previous week and posted a new lifetime high of $62.5 per barrel on the NYMEX on Wednesday. Crude closed the week on a strong note at an all-time closing high of $62.31 on Friday.

send this article to a friendThe death of the Saudi monarch led to speculation about political instability in the world's largest oil producing country and pushed up prices in the early part of the week. Unplanned shutdowns by many US refiners led to worries about supplies of refined products and held the prices in an upward trajectory later in the week.

*Disclaimer: The author doesn't have any position in the stocks specifically mentioned above at the time of writing this article. This analysis/report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.

Other articles by Rex Mathew

List of general reports on markets

List of general reports on finance

 

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Indices at new highs during the week as Reliance announce de-merger details