Tuesday, 3 November 2009

Index Outlook: The long-awaited correction

Sensex (15,896.3)

The breezy roller-coaster ride that we had expected turned in to a scary hurtle downward as the Sensex plunged 914 points last week recording the largest weekly decline in the last three months. The cut was much deeper in mid and small stocks especially those reporting adverse earnings as tolerance to negative news nosedived. The truncated week ahead is likely to be influenced by the Federal Open Market Committee meeting scheduled next week and the signals that are flashed from there.

Sudden reversal in stock prices made volumes soar sky-high, especially in derivative segment. Volumes in futures and options segment reached record levels mid-week close to the expiry of October contracts. The vicious side of the market was amply demonstrated in the way it waited for the belief in the current rally’s invincibility to get all-pervasive before reversing lower: waiting for the last bear to turn in to a bull. Sensex’ close below the 50-day moving average is a negative as is the close below the previous peak of 16,002. 10-day rate of change indicator declined in to the negative zone for the first time since August and the 14-day relative strength index has declined to 32. The weekly oscillators are however still in the positive zone implying that though the short-term trend is very weak, the medium term trend is not overtly so yet.

Though we had anticipated a correction last week, the magnitude was far greater than envisaged. We had expected a terminal corrective wave that moved sideways for a few weeks before the move from July lows ended. But the decline last week throws up a zigzag formation from July lows that could mark the completion of the C wave from March lows.

But we will wait for a confirmation of one more week to see if this decline prolongs and leads the index to a firm close below 16,000. Another fight-back by the bulls from these levels can result in a sideways move between 16,000 and 18000 for the rest of this year, indicated in our previous columns.

If the Sensex records a strong close below 16,000 next week, it would mean that an intermediate term correction is in progress that has the minimum targets of 14659 and 13885 – the opportunity that those who have missed the rally so far, are waiting for.

A rebound next week can take the Sensex higher to 16,450, 16,650 or 16,848. Failure to move above the first resistance would imply that weakness will persist to drag the index down to 14917 or 14740.

Source: thehindubusinessline

Reliance Power (Rs 138.5): Sell

We recommend a sell in the stock of Reliance Power from a short-term perspective. It is apparent from the charts that the stock was on an intermediate-term uptrend from March low of Rs 89 to its June high of Rs 210. Triggered by negative divergence and presence of significant long-term resistance around Rs 200, the stock resumed its long-term downtrend which has been in place since February 2008 high of Rs 374. Moreover, since June it has been on an intermediate-term downt rend. In early October, the stock breached its 21-day and 50-day moving averages and is hovering way below them. Both the daily relative strength index (RSI) and moving average convergence and divergence (MACD) indicators are featuring in the bearish territory. The weekly indicators are on the verge of entering in to the bearish territory. Our short-term forecast on the stock is bearish. We expect the stock’s downtrend to prolong until it hits our price target of Rs 124 in the approaching trading sessions. Traders with a short-term perspective can sell the stock while maintaining a stop-loss at Rs 146.

Source: thehindubusinessline

Rural Electrification Corp: Buy

Fresh investments can be considered in the stock of Rural Electrification Corporation (REC), a navratna public sector undertaking, which finances all the segments across the power value chain.

Secured advances with a high asset quality (net non-performing assets of almost zero) coupled with sustainable spreads are the key positives for REC when compared to most finance companies. Even after gaining more than 165 per cent this year, the company’s stock is trading at a modest 12 times its estimated FY10 earnings (assuming 15 per cent equity expansion post-offer) and at 1.6 times its estimated book value.

A power sector debt funding requirement of more than Rs 15 lakh crore over the Eleventh and Twelfth Plans is the major growth driver for REC. Its proposed follow-on public offer will augment the capital base, enabling balance sheet expansion.

The Reserve Bank of India’s recent policy change which pegs bank’s risk weights to the borrowers credit rating, will also favour the company given its AAA rating. The profits of REC rose 70 per cent in the first half of this fiscal, helped by loan book and disbursements growth of 32 per cent and 22 per cent respectively. This bettered overall bank credit growth of 20 per cent. Improvement of spreads from 3.34 per cent to 3.47 per cent, helped by better yields and lower costs, also aided the company’s net profit growth.

We expect the loan growth to continue at robust pace on the back of the wide Rs 1,50,000-crore gap between sanctions and disbursements. The margins may get some support as the proportion of private sector borrowers trends up.

At current market prices, the follow-on offer may raise Rs 2,600 crore, given the proposed offer size. This will increase its net worth by 32 per cent and bring down the debt-equity ratio from 6.3 to 4.8, reducing the risk to its credit rating. Increase in costs due to reduced reliance on tax-free bonds, may be compensated by the fall in borrowing costs from banks.

Delays in power projects leading to late disbursement and rescheduling of loan repayments, are the biggest risks for the company. Asset-liability mismatch arising out of lower maturity deposits and high duration loans is also a potential risk. Increase in interest rates later in the year may put pressure on margins as the company predominantly has fixed-rate loans, with three- or 10-year reset.

Source: thehindubusinessline

DISCLAIMER: The author is not a registered stockbroker nor a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity, index or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. The author recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and that you confirm the facts on your own before making important investment commitments.