RPower Comes at for NIFTY:

Bears are gaining support from unexpected quarters. The Index Maintenance Sub-Committee of the National Stock Exchange has decided to replace Dr Reddy’s Laboratories with Reliance Power in Nifty. These changes will be effective from September 10, 2008. Experts say this will put further pressure on the Nifty as it will increase the market capitalisation of the index while net profit will decline, pushing-up the index price to earning (PE) multiple.

This will provide another excuse to bears to go short. Brokerages are now expected to bring down Sensex targets as the P/E ratio will go up. A P/E ratio is a valuation ratio and can be calculated by dividing the total market capitalisation of the index by its total earnings.

Besides making Nifty expensive, the move will further tilt the bias in the index towards the power-sector stocks. The index already has stocks such as NTPC (which has a weightage of 5.4% in the Nifty as on July 31) Tata Power (weightage of 1%), PowerGrid (1.5%) and Reliance Infra (0.9%), representing power utilities and stocks such as ABB (0.6%), BHEL (3.2%), Siemens (0.7%) and Suzlon (1.3%), representing power equipment manufacturers.

Reliance Power has a market capitalisation of close to Rs 37,000 crore and Dr Reddy’s Lab has a market cap of Rs 10,000 crore. Therefore, the inclusion of the new scrip in the index would raise the index market cap by around Rs 27,000 crore. Reliance Power reported a net profit of Rs 94 crore during FY08 compared with Rs 475 crore reported by Dr Reddy’s Lab during the same period.

In the first quarter ended June 2008, Reliance Power reported a net profit of Rs 59.7 crore on a total income of Rs 77.67 crore in Q1 June 2008. Comparable figures of the previous period were not available. Dr Reddy’s Lab reported a net profit of Rs 210 crore during the first quarter.

Market participants say this will lift the valuations of the index as its P/E ratio will go up by few basis points due to decrease in earning per share (EPS) of Nifty.

“The liquidity on the bourse is declining and fundamental factors are continuously unfavourable. These structural changes will add further pressure on the equity market,” says an analyst. The point to note is that Reliance Power will not be generating any profit from its core operations in the next few years to come. The profit so far generated is from treasury operations. Various institutions while valuing the market, consider these aspects.

Global investors in particular use key indices as a proxy to define a market as attractive or costly. The stocks for inclusion in Nifty have to satisfy several criteria such as liquidity (measured by impact cost), market capitalisation and floating stocks.