The first quarter performance posted by Pentafour Software and Exports limited (PSEL) is consistent with the general trend in the software industry. Turnover has increased a solid 50.16 per cent to Rs 143.82 crore for the three months ended June 1999, compared to Rs 95.78 crore last year. Thanks largely to overseas exports, which now account for 97.17 per cent of PSEL's revenues. A major chunk of the revenue growth has come from two of its main lines of business namely - multimedia (2D/3D/Special effects, CBT/CD Titles and Internet) which accounts for 56 per cent of turnover and business software (Banking, Insurance, ERP and Y2K) which contributed nearly 44 per cent of the revenues.

But this revenue growth aside, operating margins at PSEL have actually taken a plunge, dipping from 44.90 per cent to 37.46 per cent. However, analysts state that this not at all surprising. Especially since the total expenditure (which has increased 70.46 per cent to Rs 89.95 crore), hasmerely grown in line with the company's increased scale of operations. Another reason for the soft operating margins is the fact that PSEL's project billings are done on a milestone basis and while fixed expenses are expensed in the quarter, the work-in-progress valuations are done at cost until the milestone is achieved. Manpower at PSEL has also grown in recent times contributing to a higher wage burden for the company.

Furthermore, despite depreciating some of PSEL's computer systems at an accelerated rate which has led to an 11.72 per cent increase in depreciation charges to Rs 20.30 crore, net profits have actually improved a solid 62.86 per cent from Rs 21.11 crore to Rs 34.38 crore. Obviously, the bottomline growth has been aided by a buoyant other income component of Rs 1.28 crore and lower interest charges of Rs 0.47 crore (Rs 6.03 crore last year).

Additionally, the company also benefits no tax provisions in view of its 100 per cent EOU status, under the Software Technology Park (STP) andElectronic Hardware Technology Park (EHTP) schemes.

A strong order book position and the fact that PSEL targets the high-end markets for multimedia and business software, augurs well for PSEL in the interim. However, it is the multimedia division that is likely to dominate Pentafour's fortunes in the future. The division is currently working on the 3D Hollywood animation film "Sandman" and has successfully completed projects like "Alibaba and Forty Theives" among others. The commercial success of these projects might well ensure that Pentafour continues well on its growth path.

Commodity stocks

The two commodity companies, Tisco and Reliance, seem to have disappointed the markets. The announcement of their first quarter results has seen their scrips take a hammering. After the announcement of Tisco's results, its share price nosedived from a high of Rs 171.50 to Rs 158. The same is true for the Reliance scrip, which fell from a high of Rs 186 to Rs 180.60 on the day its results were announced. Onthe very next day the scrip fell to a low of Rs 175.60 before recovering to Rs 180. The Kargil effect took the scrip price beyond Rs 200 but with commodity prices yet to show major gains, it fell back to Rs 186. This fall is against an 8.23 per cent rise in the sensex, clearly showing the reluctance of market players to either increase their holdings in these two sectors or to maintain a status quo in their percentage holdings.

One reason for these stocks falling out of favour could be that the profit figures for both these companies have been aided by other income. In Tisco's case other income consisted 50 per cent of PBT, while for Reliance it was 29 per cent of PBT. Unlike Reliance, whose other income is from a stream of interest and dividend payments, Tisco's other income has been driven by the sale of scrap and DEPB schemes which are unlikely to recur. Even the lease agreement which expired in 1995 has still not been renewed by the Bihar government. This delay has raised doubts about whether the saleof Tisco's cement plants to Lafarge could be completed in the current fiscal casting a doubt on the final projected earnings for the year.

However, if the recent unpopularity of these sectors is purely due to the first quarter results, it is unwarranted. The basis of the rise in commodity prices still holds and their effects would be visible only in the second half. Anyone who felt that a demand spurt would immediately push for higher prices and consequently higher realisations has still to understand the commodities market. At the start of a revival, the earnings growth cannot be linear and there are more chances of a convex growth path (initially down and later, a spurt in earnings).

In fact the first quarter results reinforce the theory of revival. The first effect of revival is seen in higher volume sales. This is because the expectations of higher prices causes bigger orders both from consumers and traders. Purchase managers tend to buy higher volumes to avoid costly purchases in the future. Tradersstart stockpiling and the entire chain starts absorbing higher volumes, even though the output of final product made out of steel, polyester, polymer is only showing small signs of revival. Seeing the first quarter results we find the trend exactly replicating the above phenomenon. Volume sales of both Tisco and Reliance are up. For Tisco steel sales were up by 6.6 per cent, while for Reliance volume sales were up by 12 per cent. This rise in volume sales has more to do with expectations than actual physical requirement.

Obviously the next step is pushing a higher price for products without comprising on volume sales. According to officials of both Tisco and Reliance, the stable demand even in the slack season has given these companies lee-way to push for small price hikes. While prices of polyesters has seen a 5 to 7 per cent gain, steel is up by a mere 3 per cent and the same goes for polymers. But once the monsoon is over, higher demand from end users would act as a catalyst for a sustained price hikefor all commodities. Hence in the second half volume sales would be higher contributing to both the topline and bottomline.

Simply because both these companies have the ability to meet the entire cost at the bottom of the cycle, any increase in prices would be directly reflected in their PBT. In addition, these corporates are MAT paying with the tax rate of Reliance being even lower, resulting in almost 90 per cent of the gain in realisations adding directly to the bottomline. In fact the sensitivity calculations in Tisco would show that for every percentage rise in realisation, profits rise by Rs 30 crore. For Reliance the gain is even more, suggesting that the current unpopularity for these scrips is only a temporary phenomenon.

Emcee (with contributions from Percy Dubash & Manish Saxena)