Boiling Oil May Spoil Race

The movement in crude oil prices will play a crucial role in deciding the direction of the Indian stock market says Ramkrishna Kashelkar

INDIAN stocks were battered as the civil strife in the Middle East sent global crude oil prices soaring. A minor recovery was seen since then. However, the future of Indian equities will remain clouded unless oil prices ease significantly. The anti-government protests and the civil war that broke out in Libya, which happens to be an OPEC member country with 1.58 million barrels per day (mbpd) oil production in January 2011, has forced several oil producers in the country to close the taps. Official estimates put the loss of production at somewhere between 500,000 and 750,000 barrels per day, while the actual number could be as high as 1.2 mbpd. The success of uprisings in Tunisia and Egypt has brought about a general unrest in other countries in the Middle East and North Africa. This has created a general fear about a similar situation in other countries, choking off the world's oil supply in the near future.

WORLD IN SHORTAGE
At present the global petroleum industry is well geared to absorb this unexpected fall in oil production caused by problems in Libya. International Energy Agency (IEA), for example, mentioned, “collectively, the IEA members have 1.6 billion barrels of emergency oil stocks at their disposal, or in aggregate 145 days of import cover for IEA members.” Founded in response to the oil crisis of 1973, IEA has 28 industrially advanced countries as its members.Similarly, the 12-member countries of Organisation of Petroleum Exporting Countries (OPEC) together hold a spare capacity of 5.19 mbpd, which can come on stream on short notice. Overall, the markets remain well supplied and there are indications that the demand-supply mismatch of the last quarter of 2010 is not likely to continue. The US, for which the latest data is available, saw 11 million barrels addition to inventories during January 2011.

RISK TO GLOBAL ECONOMY
High crude oil prices, if the trend continues, pose a significant risk to global economic recovery. According to IMF’s estimates, the global economy grew by 4.8% in 2010 and is expected to grow at 4.3% in 2011. However, the fiscal health of the world’s leading economies, be it the US, the UK, European Union or Japan, remains fragile. High oil prices can increase overall production costs, leading to inflationary pressures, which can derail the recovery process. International Energy Agency has warned of this danger repeatedly in the past with the help of ‘oil burden’ concept. Oil burden is defined as nominal oil expenditure divided by nominal GDP. “A sensitivity analysis for 2011, holding GDP and oil demand constant, indicates that, at current prices of around $90 per barrel on WTI, global oil burden is rapidly approaching the 2008 ‘recession threshold’,” wrote IEA in its monthly update published on February 10. Since then, WTI prices have scaled up beyond $100.

INDIA’S WOES
Despite being a major energy importer, India lacks any structured policy towards ensuring energy security in the times of crisis. Unlike countries like the US, China or Japan, India has not built any significant capacity to store strategic reserves. The country’s three such projects are substantially way off the schedule. India’s net petroleum imports stood at 122.9 million tonne in FY10, which cost $58 billion. During the first 11 months of FY11, the country's net petroleum imports stood at 102.2 million tonne or around $70 billion. This doubled India’s current account deficit in the first half of FY11 to $27.9 billion and is likely to reach 3% of GDP for FY11 from 2.8% last year. This means the country is increasingly dependent on foreign capital inflows to maintain the strength of its currency. A reversal in capital flows, particularly in the portfolio investments, could end up weakening the rupee. On top of this, the problem of fiscal deficit is set to worsen as the government tries to act as a shock absorber between the market gyrations and the domestic consumers. For FY11 alone, the oil sector’s under-recoveries are expected to be around 1,00,000 crore, which
is likely to push government’s oil subsidy bill beyond 40,000 crore. If the current situation continues, each spurt in oil prices is bound to make global investors jittery on the rupee’s strength and future of India’s public finances. The future movement in crude oil prices, therefore, will play a crucial role in deciding the direction of Indian stock markets.

CONCLUSION
One cannot deny the fact that it is rising demand that is leading to higher crude oil prices over a period of time. However, at times the movement in oil prices turns out to be erratic. The spurt in oil prices of 2007-08 proved too sharp for many economies to absorb, which resulted in a global economic recession in 2009. A clear danger looms large that a similar scenario could play out in 2011 also. Whichever way you look at the developing scenario, the outlook for Indian equities doesn't appear encouraging.

JAIN IRRIGATION: Stalled Fund Flow Takes a Heavy Toll

The stock has slumped on delayed subsidy payments, but looks attractive now as the company has moved to contain the fallout

Jain Irrigation's woes are not over yet as the sharp fall in its December 2011 quarter profits showed. However, its efforts to curb the rise in receivables are showing some results. Besides, initiatives such as a thrust on exports, setting up of an NBFC etc will enable it to get back on track in another couple of quarters. The worst seems to be over for the stock. 

BUSINESS India's biggest micro-irrigation systems (MIS) maker has been in trouble for the last couple of quarters as its receivables shot up on delays in government's subsidy payments. MIS, which make up nearly half of Jain Irrigation's revenues, are eligible for capital subsidy from the central government. However, with the government delaying payments, Jain Irrigation's working capital cycle has stretched to unmanageable levels.
Its outstanding debtors doubled between March 2010 and September 2011 increasing working capital investments by 60%. The company lost more than half its value on the bourses in 2011 for its inability to curb receivables.

GROWTH DRIVERS The December quarter results reveal that the company is going slow on sales of MIS to protect its balance sheet. Its MIS sales grew just 10.5% in the December quarter. This reduced its net working capital cycle by 12 days to 178 days in the December quarter. The company's PVC pipes business is doing quite well. It grew 36% y-o-y in the latest quarter thanks to healthy retail demand and exports to Africa. The company is also focusing on exports to drive its growth. It is targeting exports of $100 million in FY13 from just around $15 million in FY12. Next year it will also see its international subsidiaries contributing.
The company has approached RBI for a licence to operate a non-banking financial company (NBFC) - something that can address its working capital issue. The company hopes to obtain the licence within six months. 

FINANCIALS The company's profitability in the last two quarters was hit by mark-to-market losses on its $157-million outstanding loans. The losses stood at 59.3 crore in the September quarter and 71.1 crore in the December quarter. However, these mainly remain non-cash adjustments. The main source of pain was the interest cost, which at 250.6 crore for the nine months ended December 2011 was up 58% against the year-ago period. The net profit in the same period almost halved to 95.2 crore. 

VALUATIONS The company recently issued bonus shares with differential voting rights (DVR) in the ratio of 1:20. On an expanded equity base it is trading at a P/E of 21.3. However, sans the forex losses its profits in coming quarters will get a boost.

CASTROL INDIA:Growth On, Rising Oil Prices the Only Worry

Lubricants maker Castrol India has had another year of robust growth. Its net profit grew 28.7% in 2010, on the back of an 18% growth in sales. Amid rising oil prices, the company managed its costs well to improve the operating margins to a historical high. With strong investment in brand-building, rising oil prices could possibly be the only concern for its future growth.
Castrol’s operating profit margin at 26.7% for 2010 was better than the 25% in 2009 and, in fact, the best-ever in its history. This was made possible by a 7.8% reduction in staff cost and 3% dip in other expenses. The company has been trying to shift demand for its high-efficiency synthetic oil-based lubricants, which boosted margins. After years of stagnancy, it registered a 7% growth in volume in 2010 mainly due to an increase in the number of automobiles on the roads.
Nearly a quarter of the company’s revenues come from agricultural applications such as tractors. This has resulted in some seasonality in its sales. Its June quarter typically witnesses higher revenues, profits as well as margins. The company has been trying to lower the cost of raw materials. Earlier, the costs were 60% of net sales on an average; they were brought down to below 50% in 2009. In 2010, the costs inched up to 50.5% of net sales due to the rising oil prices.
The expense on brand-building and advertising remains the second-largest cost for the company. In 2010, it spent . 162 crore on advertising, up 8.6% from the previous year. Recently, the company entered into a fiveyear sponsorship deal with the International Cricket Council, tying up as its Official Performance Partner. This is not expected to push up the company’s advertising budget significantly. The company ended the year with a cash pile of . 619 crore, 17.8% more than in last December. Its annual capex remains at just around . 25-30 crore, and considering its final dividend of . 8 per share, which will use up another . 225 crore, the company will be left with over . 300 crore of unutilised cash.
The scrip is trading at a priceto-earnings multiple of 20.6.
The company expects decent volume and revenue growth in 2011. It is poised to maintain its steady growth in future, too.

RIL: Deal Value May Be Below Analyst Estimates

On the face of it, the decision of Reliance Industries (RIL) to sell a 30% stake in its 23 exploration blocks in India to BP appears to be a great value-unlocking proposition. However, the implied valuation of these exploration blocks appears to be lower than what analysts had assigned to them earlier. If this really turns out to be the case, there is every possibility that analysts could de-rate the company in the near term.
RIL controls 29 exploration & production, or E&P, blocks in India. The latest research reports put out by leading brokerages have pegged the net value of the domestic exploration portfolio somewhere between 450 and 500 per share. However, the current deal values 80% of these assets at close to 295 per share.
A report by Goldman Sachs dated January 17, 2011 had assigned a value of 509 per share for RIL’s exploration portfolio excluding the CBM and shalegas assets. In fact, the KG Basin D6 block alone is valued at 250 per share. In its January 21, 2011 report on the company, brokerage firm Edelweiss assigned 495 per share as value of its firm reserves and exploration upside.
The latest research report by HSBC on RIL, however, is somewhat more conservative. It values the KG-D6 block at 203 per share, other E&P blocks at 68 and exploration upside at 111, totalling Rs 382 per share for assets excluding PMT and shale gas. Analysts are miffed over the lower valuations, but are unable to explain further as it was not immediately clear which 23 of the 29 blocks were part of the deal. So the 23 blocks could be predominantly exploratory, rather than in the development phase. Alternatively, the discount could be extended for gaining access to BP’s technical expertise.
RIL had cash equivalent of nearly $7.1 billion on its books at the end of December 2010. When adjusted for cash, its net debt was close to $2.6 billion. The company’s scrip, which gained 2.5% before this announcement was made, has been underperforming the broader market in the last several months. Since last February, RIL’s scrip has lost around 2% against a 13% gain in the BSE Sensex.
The deal, no doubt, unlocks a lot of value for the company by bringing in a chunk of cash towards future profits. However, investors should keep in mind the fact that this in itself may not prove to be a positive trigger for the company’s scrip. Taken as a benchmark, this deal could lead to analysts lowering the value of the firm’s exploration business as well as price targets.

BUDGET WATCH: A Shot In The Arm

There are certain companies which generate specific investor interest as they stand to benefit more from some of the Budget provisions

The countdown for the Union Budget has started. In the run up to this event, there is often a pre-Budget rally and major movements after the Budget depending on the measures announced. There are certain companies which generate specific investor interest since they stand to benefit more from some of the Budget provisions.
The Union Budget outlines the government’s priorities in several areas including, social sectors, infrastructure, education, health and allied sectors besides the farm sector.
For instance the government’s Budget for implementing its Accelerated Irrigation Benefit Programme (AIBP) has gone up from 4,500 crore in FY07 to 11,500 crore in FY11, which includes 1,000 crore specifically for microirrigation projects. It is no wonder then that the scrip of Jain Irrigation, which manufactures irrigation systems and is India’s largest micro-irrigation company, benefits from a strong upswing in the weeks ahead of the Budget every year.
The government’s focus on improving basic education has resulted in the allocation for this segment going up three-and-a-half times in the past four years to 35,000 crore for FY11. Companies such as Educomp Solutions, which reaches out to over 1.2 crore students through its various programmes, typically see a run-up thanks to this.
The government’s increased spending in these areas has played a key role in growth of these companies. In the past four years, Jain Irrigation’s growth rate has remained above 33% every year, which it expects to continue for a few more years. The revenues of Educomp Solutions have almost doubled year after year for the past four consecutive years.
From the stock market’s point of view, the Railway Budget, which is presented a couple of days before the Union Budget, is also important. The railway ministry’s attempts at modernising, electrifying and expanding its network through a private public partnership (PPP) have helped bring in more business for a few listed companies.
Ahead of the railway budget, there is heightened investor interest in Kalindee Rail Nirman, for instance, which is in the business of railway signalling, electrification and track laying and related civil work. Not only do the average volumes rise substantially in February from January, the price also witnesses an uptrend till the last week of February.
This trend is not restricted to Kalindee Rail alone. Other companies that have related businesses also witness a similar trend year after year include private sector wagon manufacturers, such as Texmaco and Titagarh Wagons or component suppliers for railways such as Stone India and Hind Rectifiers.
The railway budget presented in February 2010 for FY11 had the highest ever planned outlay of 41,426 crore, nearly double of 23,475 crore of FY07. This included several major projects such as metros, dedicated freight corridors, 1,000 km of additional rail lines and incremental loading capacity by 54 million tonne apart from acquiring some 18,000 wagons.
A short-term investor can take benefit of these swings in the market, which have become fairly predictable over the past few years. However, it is not necessarily that some of these companies really benefit from the Budget announcements.
Very often government contracts and tenders get delayed. For instance, in FY10 there was a major delay on the part of the railways ministry in bringing out orders for wagons which frustrated a leading manufacturer, Texmaco. In its annual report for the year published in May 2010, the company vented its frustration. “It is regrettable that even after the elapse of nearly 14 months, Indian Railways are yet to release the wagon orders for the year 2009-10. Ironically, there is an all round clamour by the industry on account of shortage of wagons. Yet, the continuing delay in releasing the overdue wagon orders is rather inexplicable,” it mentioned.
Even when the orders do materialise, foreign or local competitors could impact the listed company’s ability to win those contracts or put pressure on margins. Again, not all related to these sectors benefit equally. Despite the success of Educomp, leading publisher of textbooks Navneet Publication has seen its revenues growing at only 17% annually over the past four years.
Similarly, the trend in price rise is highly dependent on overall market conditions. In February 2010, the scrip of Kalindee Rail rose from 190 levels at the end of January to a peak of 218 by February 15. However, the scrip ended the month at 165 as the markets crashed. Educomp, which typically rises 15-20% within the first three weeks of February, also witnessed a continuous downward journey in February 2010.
In 2011, so far weak market sentiment has weighed on most of these scrips, which have lost value in February despite higher volumes. There are no signs of a‘pre-Budget rally’ as yet. It may have something to do with the fact that Parliament has not been functioning with doubts being cast over the budget session. Much will hinge now on what the finance minister delivers on February 28 in the back drop of a series of scams, high inflation and policy paralysis.

Kemrock Industries: Kemrock Earnings Growth Can Take Care of Debt Pile

Company’s valuation has dipped to attractive levels of 15.5 times now

Vadodara-based Kemrock Industries continued with its impressive financial performance in the December 2010 quarter after equally impressive June and September quarters. It posted more than 50% jump in net profit while the revenues almost doubled from the year-ago period. A sharp jump in interest and depreciation costs and higher tax rate were the main factors responsible for the slower growth in bottomline compared to the topline. Kemrock Industries is India’s largest producer of fibre-reinforced polymers (FRP) and derives two-thirds of its revenues from exports. The company became the first in India when it commissioned a 400 TPA carbon-fibre plant in May 2010 with a capex of 200 crore. In June, it went on to acquire 80% stake in an Italian company Top Glass. In FY10, it had also doubled its resins and quadrupled its FRP capacities. Recently, it signed an MoU with Swiss company DSM Composite Resin to manufacture saturated polyester and other specialty polymers in India.
Last few quarters saw the company benefiting from its mega-investment cycle. Kemrock’s December 2010 quarter net sales crossed 200 crore. Interest and depreciation costs more than doubled while the tax rate at 29% was higher than 25% in the year-ago period.
The heavy capex has resulted in the company doubling its gross block between March 2009 and June 2010. This trend seems to be continuing since then. The value of net assets as on December 31, 2010 at 946.6 crore was around 15% higher from June 2010. Pursuing a high-paced growth within a short-time span has resulted in a heavy debt burden, a series of equity dilution and promoter stake in the company coming down. Since the start of 2008, the company’s equity increased 58%, while the promoters’ stake dipped to 26.9% from almost 38%. The debt-burden at 1,056 crore was its highest ever as of December 2010 end. Still, a higher growth in earnings of past several quarters meant that the debt-to-equity ratio has not gone up. From 1.9 as of end-FY09, the debt-equity ratio has come to 1.77 by end December. Last year, its scrip was highly volatile on bourses, though it outperformed the Sensex by a wide margin. Considering its current market valuation and the earnings for December quarter, its valuation has dipped to 15.5 times its earnings for the past 12 months.

CAIRN INDIA: Deal Uncertainty Keeps Company Undervalued

Amidst uncertainties surrounding its acquisition by Vedanta, Cairn India posted a strong December 2010 quarter result, which was substantially better than September 2010 quarter’s numbers. Higher production and higher oil prices enabled it to become cash surplus during the quarter. The company is readying for higher production from its Rajasthan fields, while investing in exploration of other blocks. The Mangala field ran at its plateau production of 125,000 barrels per day for the first time in the December quarter. As a result, the company’s share of oil production surpassed the 100,000 barrels per day level. The company’s realised price during the quarter at $74.3 per barrel of oil equivalent (boe) was 15% higher against the year-ago period. Its net realised price represented around 13.5% discount to the average Brent price for the period, in line with the company’s guidance of 10-15% discount.
The Mangala field, which was the first one to go on production in the company’s Rajasthan block in August 2009, has reached its peak production level of 125,000 bpd as approved by the government and its joint venture partner ONGC. The company is awaiting approvals to ramp it up to 150,000 bpd. Simultaneously, it has begun development work on the secondlargest Bhagyam field. Production from this field is scheduled to begin in the second half of 2011, which will be ramped up to its approved plateau of 40,000 bpd by the year end.
In the meantime, cashflows from operations jumped by 30% compared with the September quarter to around Rs 2,039 crore. This enabled the company to become cash surplus. At the end of the December 2010 quarter, the company’s cash stood higher than its outstanding borrowings by Rs 870 crore. With this, the company replaced its Rs 4,000 crore loan facility by raising Rs 2,250 crore from debentures. This helped the company save on interest cost while earning higher other income compared with the preceding quarter. The interest cost for the December quarter was Rs 74 crore, 42% lower than the September quarter. Production at Bhagyam is likely to commence in the second half of 2011. The company will start drilling exploration wells off Sri Lanka.
With the approval for its acquisition by Vedanta group still pending, the company’s valuations have suffered. A few brokerage houses believe the scrip is available at reasonable price. According to Kotak Securities, the company is currently trading at 6.3 times its expected earnings for FY12. Elara Securities also said that, but for the uncertainties over its acquisition, the scrip could have gone up to Rs 450 on the back of rising crude prices.
Retail shareholders may feel relieved by Cairn India’s refusal to accept any adverse condition for approval of its acquisition.

MRPL: Outlook positive due to better margins,capex

THE 21% net profit growth that Mangalore Refinery and Petrochemicals (MRPL) posted for the December 2010 quarter could have been better if the heavy forex gains of last year were not taken into account. Hence, the company’s performance should not be judged from the reaction of stock market. The MRPL scrip got a severe beating on Wednesday as it fell more than 8% to its 52-week low in spite of a healthy December quarter show. At the operational level, the company’s performance was much better, with gross refining margins at $6 per barrel and highest ever throughput of 3.49 million tonne. The company’s operating profit grew 87% against the year-ago period. However, the 153-crore foreign exchange gains it had booked last December meant that the growth in gross profit was just 14%. Another factor that affected profit growth during the quarter was the provisions for pay revisions of non-managerial staff. The company wrote off 56 crore during the quarter towards arrears of pay revisions with effect from April 2007.
The company is working on a megainvestment programme, which will almost triple its gross block by end FY12. It is implementing a 14,000-crore refinery expansion project to be completed by October. This will not only expand its refining capacity from 12 million tonnes to 15 million tonnes, but also improve its ability to process cheaper varieties of crude oil, which are heavier or with higher sulphur content.
Another major project will add 0.44 million tonnes of polypropylene capacity by April 2012 at a capital cost of 1,800 crore.
MRPL is also working with ONGC to set up an aromatics complex in a special economic zone near its refinery in Mangalore. The 5,750-crore project is scheduled to be commissioned by end FY13.
Considering the recent fall in market value and gains in corporate earnings, the company’s valuations dipped to a price-to-earnings multiple (P/E) of 12.3. The global refining industry appears to have come out of the woods with gross refining margins, or the money a refiner makes on refining each barrel of crude oil, moving up in the December quarter. The first few weeks of the March 2011 quarter indicate that the strength continues, which can prove a key positive for the company going ahead.

OIL INDIA: Co rides high on higher prices of natural gas

The Assam-based oil producing company, Oil India, is reaping gains from higher natural gas prices as it replicated the September 2010 quarter performance and posted good profit growth in the December quarter, too. The strong performance is set to continue as production growth is likely to be steady.
Profits from the natural gas segment jumped nearly four-fold to . 165.3 crore, contributing nearly 12% to the company’s pre-tax profits as against just about 4% a year ago. Gas production during the quarter, although higher on a sequential basis, was down 1.6% against the year-ago period at 0.62 billion cubic meters.
The company also benefited from better realisation for its crude oil after doling out discounts to downstream marketing companies. At $67 per barrel, the net realised oil price was the highest for the company in the past several quarters — 14% higher on a year-onyear basis — and boosted the oil segment’s sales by 11% to . 2,047.5 crore. The company, which is targeting 1 million tonne oil production every quarter, improved its output by 2.6% to 0.93 million tonne during the December quarter. A 3.8% appreciation in rupee proved to be the only negative factor.
The pipelines division posted a profit for the first time in the December quarter. The PBIT from the transport segment was at . 9.8 crore for the December quarter compared with a loss of . 18.3 crore in the year-ago period. It also booked a one-time gain of . 51.5 crore towards revision in transportation tariffs pertaining to earlier years.
The company reported a 26.6% growth in net profit at . 908 crore, while revenues for the quarter were up 17% at . 2,388.6 crore. The subsidy burden the company shouldered was around 19.5% higher than the year-ago period at . 558.6 crore. However, the December quarter’s profit was lower than the September quarter numbers as staff and depreciation costs soared.
Considering the latest earnings and the correction in the scrip over the last few weeks, the price-to-earnings ratio stands at 11.6, lower than ONGC’s 12.8. The company has lined up an aggressive capex programme of . 7,400 crore for FY11 and FY12 combined. More than a quarter of this is earmarked for inorganic growth, while nearly 60% will be spent on exploration and development. With steady production growth, low subsidy burden and substantial capital expenditure lined up, the company’s profit growth is likely to continue.

JAIN IRRIGATION: NBFC will sow seeds of growth

THE concern in the market over Jain Irrigation’s plan to foray into “unrelated” business and dilute equity appears farfetched. A dedicated non-banking financing company (NBFC), which Jain Irrigation plans to set up, can offset problems due to rising receivables. An equity dilution will bring down debt and save interest cost, which may be earnings accretive.
Huge working capital and rising debt have long been key concerns for the company. The proposed change in the objects clause to include ‘power generation’ concerns its existing windmills and there are no further investments planned in this area.
The scrip has recovered nearly 12.5% in two trading sessions after losing over 30% in three days in response to the company’s announcements of its plans. A weak financial performance during the December quarter also dragged the stock down. The 25% profit growth was mainly due to a one-time receipt of . 39.8 crore as VAT refunds for five quarters. The refunds were under Maharashtra’s incentive scheme for investments and employment generation, and the company is likely to benefit from this scheme in the coming quarters as well.
The company’s micro-irrigation systems business earns half of its revenues from the government in the form of capital subsidy to farmers. Delays in government’s payments have increased the receivables for the company, which stood at over . 1,000 crore at the end of March 2010 and is likely to go up to . 1,300 crore by the end of March 2011. As the company expects a 30%-plus growth from this business in the coming years, the bulging working capital problem needed a solution. The proposed NBFC will address this issue.
The . 700 crore the company plans to raise by issuing shares to qualified institutional investors will help it bring down debt from the current . 2,100 crore to around . 1,500 crore. In a rising interest rate scenario, when the company is paying interest at around 12% on an incremental loans, this could save the company . 60-70 crore in interest cost annually. This will result in the growth of the company’s earnings per share (EPS).
The promoters plan to subscribe to 62 lakh warrants, to ensure their stake in the company doesn’t fall too much.
Jain Irrigation’s business is workingcapital intensive, as is evident from the fact that its investment in working capital at over . 1,700 crore was 23% higher than in fixed assets as on September 30, 2010. All this working capital needs financing, which has increased the debt burden and interest costs, which eat into at least one-third of its gross profit. At a when interest rates are rising, its plans for equity dilution and setting up an NBFC should be seen as attempts to mend its house in time and achieve its aim of aggressive growth. Investors should be worried if these steps get delayed.