Monday, February 14, 2011

Nifty change: The good, the bad and the ugly

I have been pleading for long that it was high time Suzlon went out of the Nifty. It had absolutely no business to be in the index for so long, after being a serial underperformer and actually eating away some of the Nifty’s earnings. Finally, this stock is getting out and it will be replaced by Grasim. So let’s look at the good, the bad and the ugly aspect of this change.

First the good part, it’s a good riddance. For all the promise Suzlon had, you could only give the company this much time. After all, even Yuvraj Singh has shown lot of promise over last 11 years, but somehow has never translated that at the highest level of test cricket. Suzlon was taken into the Nifty as long as 4 and a half years back, in June 2006. It all looked hunky dory then of course. In FY07, Suzlon posted net profit of 864 cr and went on to better that in FY08 with 1030 cr. In FY09 though, the profit came down to 236 cr and by FY10 it had become a loss making company, posting a loss of 983 cr. By all indications, FY11 net loss is likely to go up to over 1100 cr.

From the time Suzlon went into the Nifty, it’s down 75%; during same period, the Nifty is up 82%. That’s some statement.

Grasim on the other hand is likely to post a significant profit number and with its free float weight being much higher than that of Suzlon, my initial calculations show that it will add around 3 to the Nifty EPS. So if the Nifty was to trade 15x, it goes up nearly 50 points without any effort. So that’s the good part about this change.

Now, let’s come to the bad part – of all the companies available to the NSE, they could find only Grasim to replace Suzlon? As much as I was relieved to see Suzlon go out of the index, I was aghast to see Grasim going back there. It went out of the index in April 2010 and to my mind has done nothing to warrant a selection back to the index in a span of 9 months. In fact, it’s going through a demerger and via which, the cement business will go out to UltraTech cement. There will be a holding company discount that Grasim will have to contend with and cement in any case is well represented by ACC, Ambuja and even JP Associates. Or may be, the exchange believes that Grasim needs to represent the VSF industry of the country, which I think is a bit far fetched. The other factor could be due to the fact that the choice of stocks was restricted as the NSE has a criterion of an incoming stock having at least twice the free float market cap of outgoing stock and has an impact cost of 0.5% or lesser.

And now let’s come to the ugly part, which is that the exchanges are really behind the curve in terms of selecting the companies to represent the index and also selecting the criterions for the same. While Suzlon is out, it does not absolve the committee for keeping it there for far too long and I am going to give some examples of companies that deserve representation in the index and are not there and also companies which should not be in the Nifty but somehow are still there.

My research shows that Reliance Capital, Reliance Power and Ranbaxy have absolutely no merit in being in the Nifty anymore. In fact Reliance Power had no business getting into the Nifty in the first place. On the other hand, there are companies like Lupin, Nestle, Asian Paints, Mundra Port and even REC which should be the part of the index.

The combined weight of all pharma and FMCG stocks in the index is 12.5%, which is low, especially at times when you need defensive stocks in the basket to counter some negative sentiment. On the other hand, financials have a massive 24% weight on the index and as we have learnt from the last global crisis led by sub prime issue, this is not exactly the most stable sector.

Take the case of Ranbaxy. Its free float market cap has come down to as low as Rs 7,300 cr and if you replace it with let’s say a Lupin, it will increase the weight of pharma by about 30 basis points without changing the overall composition of the index. Also, Ranbaxy is now technically a Japanese company where disclosures going forward may not be as strong as they used to be and as we have seen in the past with companies like ABB and Siements, most of these MNCs see a dip in financial performance, followed by a delisting/open offer. Lupin on the other hand has been a consistent performer, a wealth creator and even in terms of financial performance, Lupin has been far more consistent. Stock market wise, Lupin has gone up 310% over last 2 years while Ranbaxy is up 34%.

To my mind replacing Ranbaxy with Lupin would solve 2 purposes. It would make the index less vulnerable to the swings of Ranbaxy’s financial performance and at the same time, it will increase pharma’s weight in the index, thus providing some stability at bad times.

Second, let’s take the case of Asian Paints and Nestle. Both these companies have respected their equity. Asian Paints has never diluted its equity and Nestle hasn’t done it since April 1993. Both these companies have high free float, high market cap and in fact in both cases, a free float adjusted market cap of Rs 11,500 cr is higher than that of Reliance Capital, DLF or even a SAIL. Financially also, both these companies have been proven outperformers. The only problem with these stocks is that they are not very liquid and at times the impact cost would be an issue, which is one of the criterions of the stock selection.

So even if we have to leave out both these stocks, Mundra Port and REC to my mind would be far better than Reliance Power and Reliance Capital. The financial performance of both these stocks and the volatility of stock prices would corroborate that. I am comparing the financial performance of Mundra Port & SEZ with Reliance Power and Power Finance with Reliance Capital.

Company 9-mth FY11 sales 9-mth FY11 profit Free Float m Cap
Rel Power 559 NA 6,608
Mundra Port 1233 651 7,147
Reliance Capital 3,798 285 5,411
REC 5,950 1,869 8,529
* All data in cr

Stock 1-year change 2-year change
Rel Power -17% +8%
Mundra Port +12% +95%
Reliance Capital -42% +2%
REC +11% +194%

To be fair to Reliance Power, it’s best is yet to come. It may have good numbers when all the projects get operational. But then, that’s promise and not delivery. When there are proven contenders, why do you need to punt with sheer promise?

Conclusion: The exchanges need to change some of the parameters to include stocks in the Nifty. This should be a dynamic process and should keep changing as the scenario evolves.

Disclaimer: The author of this article does not invest/trade in stock markets including derivatives. His only exposure to stock markets is via the stock options of TV18 and Network18 given to him by his company as part of his compensation


  1. i like lata's question to u. y have a composition which is only bullish?

  2. @Anu, The answer lies in my article. The same question was asked by my one of my good friends. I am not arguing for bullish composition. In fact far from it. I am arguing for more representation of pharma and FMCG and less of banks, which in a bull market would move the index far lesser than a bank heavy index. Right? Let me know if you have any more query

  3. I personally feel that SUZLON may give better eanring possibility on coming year considering its business model...and will not surprise if like GRASIM in/out to nifty in short period...again suzlon adds to nifty...By the way welcome to the community of blogger

  4. I hear you today morning telling that long position seen in SUZLON too...i wish my prediction goes right...Rakesh Jhunjhunwala said ones- IF ITS A PRETTY GIRL SOMEONE WILL DEFFINETLY COMES TO HER- and other will follow.

  5. I personally feel HIGHER THE CRUDE BETTER FOR PRAJ-SUZLON....I forget that corelation earlier