Replacements to impact Sensex EPS

Higher weightage and P/E ratio of incoming stocks are likely to change earnings profile, feel analysts.

The reshuffle in Sensex stocks is likely to impact 2011-12 estimated earnings for the index and also keep the outgoing index scrips, Reliance Infra (R-Infra) and Reliance Communications (RCom), under pressure. The two stocks, to exit August 8, tumbled six to eight per cent on Monday. On the other hand, Coal India and Sun Pharma, which replace the outgoing ADA Group stocks, gained nearly one per cent, despite poor market conditions.

“RCom and R-Infra’s combined free-float market capitalisation is around Rs 15,300 crore. Coal India and Sun Pharma’s free-float market cap is around Rs 44,000 crore. This will lead to a change in Sensex 30 stocks’ weightage and, consequently, Sensex-based ETF (exchange traded funds) and index funds’ composition. This will ultimately put pressure on existing Sensex stocks, along with RCom and R-Infra and reward Coal India and Sun Pharma,” says A K Prabhakar, senior vice president, equity research, Anand Rathi.

Most research heads say it is difficult to assess the impact before the actual weightage is known. On earnings, RCom, according to Bloomberg consensus estimates, is expected to report a 23 per cent drop in net profits and R-Infra to report 14.2 per cent growth. Their cumulative weightage in the Sensex is about one per cent. Both Coal India and Sun Pharma’s earnings are expected to grow at 28 per cent in 2011-12. Also, the two are likely to have a higher weightage, of over three per cent, which means a change in the earnings profile of the Sensex.

Already, after the concerns relating to input price pressure and interest costs, the Sensex earnings estimates have been revised downwards from about Rs 1,320 a share to about Rs 1,200-1,220 per share. Any negative or positive change will have impact on valuations of the market. “We are estimating Sensex earnings per share (EPS) of Rs 1,200 for FY12. With inclusion of the new scrips, having higher weightage in the Sensex compared to those which will exit, overall Sensex EPS will be around one per cent lower or Rs 12 per share for our estimated EPS of FY12,” says Rajat Rajgarhia, director research, Motilal Oswal Securities.

He and others believe since companies with a lower price to earnings ratio are being replaced with those having a higher one, this is going to have a negative impact on the Sensex EPS.
 

EPS ACCRETIVE
	Weight in Sensex	FY11 EPS (Rs)	FY12E
			EPS (Rs)	% chg^	PAT (Rs cr)
RCom	0.6	7.3	5.6	-23.3	1,110
RInfra	0.5	57.0	65.1	14.2	1,731
Total	1.1				2,841
Coal India	2.1*	17.5	23.9	36.6	15,125
Sun Pharma	1.4*	16.9	20.2	19.5	2,087
Total	3.5				17,212
^ year-on-year; * Approximate figure                                                                        Source: Bloomberg

 

SENSEX CHANGES
Date# (A)	Effective Date (E)	Change in price (%)

Company(A)
to (E)1 mth
from (E)Company(A)
to (E)1 mth 
from (E)   Outgoing  Incoming    Oct 22, ’10Dec 6, ’10ACC-0.94.7Bajaj Auto6.9-16.3 May19, ’10May 26, ’10Grasim-28.4-2.7JSPL1.13.3 Apr19, ’10May 3, ’10Sun Pharma-11.08.0Cipla1.5-4.0 May15, ’09Jun 29, ’09Ranbaxy Lab.29.55.1Hero Honda13.218.6 Jun17, ’11Aug 8, ’11Rel. Infra*-5.8NACoal India*0.4NA Jun17, ’11Aug 8, ’11RCOM*-7.3NASun Pharma*1.6NA * Returns are till date; # Date of announcement                                                                  Source: BSE India and CapitaLine

PRICES
Beside the change in earnings, there will be pressure on the prices. On the past three occasions when companies were excluded from the Sensex, they lost on an average about 13.4 per cent. On the other hand, those coming in gained 3.1 per cent from the date of announcement to the effective date. Although a change in Sensex scrips does not have any bearing on the investment arguments from a fundamentals’ perspective, pricing action is seen due to selling pressure on excluded counters and buying in companies which are included. “Historically, the stocks which do not perform well have been removed and those which do well are included in the index. According to our calculations, Coal India will have a weightage of around 2.1 per cent and Sun Pharma 1.4 per cent, which is bound to have some impact on the affected scrips,” says Prabhakar

Both R-Infra and RCom are down by about 50 per cent over the last year as against the Sensex, which is trading at the same level as a year before. In 2010-11 on a consolidated basis, RCom reported a 71.6 per cent decline in consolidated net profits, whereas R-Infra posted a marginal 2.1 per cent gain. Since their combined weightage is one per cent, if the new entrants get about 3.5 per cent in the index, the rest will also lose some weightage, which is also why existing Sensex stocks could witness pressure on their prices.