What on earth have the markets been smoking lately?

A lot of, power, telecom and capital goods laced with a bundle of gas over some oil stocks.

What on earth is going on here? That must have been the reaction of most observers watching the vertical climb of our stock market indices, ever since Ben Bernanke decided to lower interest rates for inter-bank overnight borrowings in the US.
But stock market traders across the globe have reacted as if he has handed them a lottery with only one ticket to draw from. They reckon that Ben is a jolly good fellow who will keep on giving them lollies, every time they cry after making fools of themselves in the market.

It is no longer certain that Bernanke will be in a very benevolent mood when he sits down next to consider more gifts to market traders. It seems Uncle Sam, who put Bernanke in his chair, tricked him into handing out a big lolly last time by claiming that jobs were being lost. It has now turned out that Uncle Sam was bluffing, jobs were being added at a good pace.

Credit markets have stabilised and crude oil prices remain high, which may push up inflation -- more reasons for Bernanke to be less benevolent in future. But, global markets seem to be least bothered. They still seem to believe that there will be a pack of lollies at every corner.

We in India have been among the most exuberant in recent weeks. Except for a short blip when our politicians in Delhi seemed all set to challenge each other for a face off in a general election, our stock indices have been running on steroids. And the omnipotent Ambani brothers have led the charge and how!

Reliance Bubble?
As the Sensex moved past 18000, the Ambanis crossed another milestone - that of the richest family on earth. The combined wealth of Mukesh and Anil is now over $90 billion, more than the net worth of Walton family promoters of Wal-Mart. Now consider this, only 53 countries had GDP of over $90 billion in 2006 as per World Bank data!

Reliance Industries, Mukesh's flagship, is the best performing large-cap index stock anywhere in the world this year by a wide margin. The stock has been on a relentless up-move, triggered by speculation on pricing of natural gas from its KG Basin fields and expectations of fast expanding retail operations. The gas pricing has now been finalised and it is a fair deal to Reliance. High crude oil prices will ensure record refining margins at its refinery and the petrochemicals businesses are also doing very well.

But, do all these factors many of them known even earlier warrant a more than doubling of the stock price? Reliance's much talked about retail rollout is slowing down as the company is facing resistance in many states.

Given the uncertain political scenario at the centre and possibility of an early election, it is unlikely that state governments will move in favour of the company - though it has every right to receive protection from violent protestors.

Even if the company manages to expand its network, using the famous Reliance ability to work the system, how profitable are these stores going to be given the rush of new players into retail and prohibitive property costs? The small neighbourhood I live in already has seven modern branded retail stores on one street, including a Reliance Fresh! It is doubtful if anyone other than the landlords are going to make any money out of the retail revolution anytime soon.

Reliance Petroleum, the latest jewel in Mukesh's crown, now boasts of a market capitalisation of close to Rs78,000 crore. This is for a company, which is setting up an oil refinery and may start operations in another two years if all goes well. Many things can go wrong in between; the US economy may cool off further, which will lower fuel demand and bring down prices.

Margins are already under pressure despite record crude oil prices, though Reliance Petroleum will enjoy higher than industry margins by processing heavier crude oil. The US dollar may weaken further, making exports of refined products less lucrative. Domestic demand is not rising fast enough to absorb the possible surplus capacity.

RPL's market value of Rs78,000 crore seems even more incredible when the total project cost of the refinery is Rs27,000 crore! So, even when the project is at the implementation stage, the company is enjoying a value of nearly thrice the total cost. Once the refinery becomes operational, imagine the future value it must generate to justify these valuations!

To put it in another way, RPL's current valuation is nearly two-thirds of Infosys. That much wealth was created without even 5 per cent of the effort Murthy, Nilekani and thousands of Infosys employees put in over the last 25 years to make Infosys what it is today. Reminds you of website valuations in the late '90s? Wait until you hear about the miracles that the Anil Ambani Group stocks have performed.

Not to be outpaced, Anil Ambani has also taken a leaf out of big brother Mukesh's 'wealth creation strategy'. If Mukesh can generate so much wealth just by taking a new project public, why can't Anil? So, he decided to take hive off the big power projects from Reliance Energy and announced the creation of Reliance Power. How much capacity is Reliance Power going to build? The sky is the limit it seems, as the company has announced plans for 12 projects with an aggregate capacity of more than 24,000 MW. That is more than the existing capacity of NTPC, the biggest power generation company in the business now. Impressive, indded.

What else can Reliance Power do? There is some market talk of huge cement plants, which will use the fly ash from its own power plants as raw material. Some reports suggest that the potential capacity may be more than the existing capacity of the entire cement industry in the country. Even more impressive! Where will the company sell all that cement? Please don't ask such dumb questions!

But how profitable are these projects likely to be? Reliance Power's flagship project will be the 4,000 MW ultra-mega power project at Sasan, which by the way is its only project that can be implemented anytime soon.

This project was awarded to Reliance Energy after the earlier awardee, Lanco-Globeleq, was disqualified. The tariff quoted by Reliance is Rs1.2 per unit, which must be among the lowest anywhere in the world. When the project was awarded to Lanco, many doubted whether the project would ever be profitable at such low tariffs. Now that the project is with Reliance, the markets have no doubt it will be a money-spinner.

All the troubles Reliance Energy continues to face on its 7,500 MW Dadri project in Uttar Pradesh have also been overlooked. Even nearly two years after announcing the project, it is still not clear if the company has completed its land acquisition. It does not help that the current Uttar Pradesh government is sending not very supportive signals over the project because of Anil Ambani's political interests. Nothing much has been heard about a similarly ambitious project proposed in Orissa, announced last year.

When the Reliance Energy stock was moving on all these fantastic news flows, came the announcement that the company would develop a huge township in Andhra Pradesh. The centrepiece of this township is to be a 100-story high-rise, the tallest in the country - no less. And the stock jumped another 12 per cent!

All these stories of fantastic valuations pale in comparison to Reliance Natural Resources or RNRL. Here is a company that was originally supposed to buy natural gas from Reliance Industries and supply it to various Reliance Energy projects. In other words nothing more than a gas trader. Then markets started to see infinite possibilities for the company in the entire energy space from exploring for oil and coal bed methane to city gas distribution. The company won three or four coal bed methane blocks in Rajasthan and a small oil block in Mizoram in the last round of NELP bidding.

These are all exploration blocks, mind you, and RNRL has to drill and find something under the ground. But the RNRL stock has behaved as if the company is already sitting on huge oil and gas reserves.

RNRL now boasts a market capitalisation of around Rs13,500 crore. Incredible as it may sound, the last leg of the surge came after the company applied for a licence just an application that might have cost a few thousand rupees for city gas distribution. That news pushed up its market value by around Rs3,000 crore in a single day. Indraprastha Gas, the leading city gas distributor in the country with a monopoly in Delhi and now expanding to other cities, has a market value of just Rs1,900 crore!!

Can't we do a China?
'This week Chinese stock market traders could not make any money because the markets were closed for holidays', was the opening line of a recent article in a major international financial newspaper. Yes, over the last year or so this was the simple rule for Chinese traders. If the market was open, they made a truckload because the only way for prices to move is up.

The way our markets are behaving, we seem to be in a hurry to absorb this 'Chinese doctrine' of stock market investing. Also, it may impress M/S Karat, Bardhan, Yechury & Co. that we are following the 'Chinese model' of 'market socialism' and not the evil capitalism promoted by Uncle Sam and its cronies. Then may be, they will spare our markets from their 'tough-talk' whenever there is a political crisis next. Given the current political undercurrents, that can be anytime.

If the Mainland Chinese index can trade at an earnings multiple of over 50, why should the Sensex limit itself to a multiple of just half of that? After all, Indian companies are supposed to have better earnings visibility, better and more transparent managements, global capabilities and all that. And of course the clincher, we are a democracy! So, don't we deserve a better valuation than even the Chinese?

Those who argue on the these lines often fail to consider many factors that make the Chinese stock markets, well, different. As most companies are government-owned, supply of stocks is highly limited. When too much money chases too few assets, prices obviously go through the roof. Provincial governments own many Chinese companies and it is in the interest of government officials to push up stock prices, whichever way they can. There is also talk of massive price rigging and insider trading in Chinese stocks.

Anyone who has ever visited a casino in a city with even a small Chinese population would readily agree that the Chinese are inveterate gamblers. Watching them gamble, it may appear is their most natural of all pastimes. No wonder that the Chinese territory of Macau has overtaken Las Vegas as the gambler's paradise. The trouble is, the Chinese seem to approach stock market trading just the way they do gambling.

Those of us who have observed the markets for the last two decades or so have seen phases where it was difficult to differentiate trading from gambling. When our very own pied pipers like Harshad Mehta and Ketan Parikh played the tunes of 'replacement values' in the early '90s and 'ICE' economy later, we swallowed it all only to lose everything and regret it later. One of the constants in these earlier phases of exuberance was that the big falls were preceded by swift and vertical surges. Are we in for another déjà vu?

Most seasoned and sensible investors have long argued that Chinese stocks are way past bubble levels. For the Chinese, it may be just one of the many bubbles as they are now in the midst of 'bubbles among bubbles' stock bubble, property bubble, export bubble, FDI bubble, name your bubble, and they have it.

While it may be creditable if we can catch up with them in many areas of economic activity, stock market valuations are definitely not one of them. We will be better off without this fancy for creating bubbles. When they eventually burst, we may not be able to absorb the pain the way Chinese gamblers in casinos do... by lighting the next smoke and ordering another drink.

Source - domain-b