VEDANTA-CAIRN DEAL

VEDANTA-CAIRN DEAL Time Now to Cash in on Rising Global Oil Prices 

ONGC’s nod for Vedanta Group’s acquisition of Cairn India marks the end of the year-long saga of anxiety and uncertainty surrounding Cairn’s fate. Although Cairn had to finally accede to a few unfavourable covenants, those are already discounted in its share price. The share price should now reconnect with international crude oil prices — a correlation that had gone awry for the past one year.
Prior to the announcement of Vedanta’s acquisition, Cairn India had become a proxy for the equity investors to benefit from rising oil prices. Till August 2010, when the deal was announced, Cairn’s share was enjoying a nearly 90% correlation to the global oil prices. However, when oil prices started going up from December 2010 and gained over 21% within 12 weeks to cross $100 per barrel mark in February 2011, it became clear that the link had broken. Cairn’s share stayed range-bound between . 320 and . 340.
Now that the deal overhang is behind the company, there is a strong case for it to resume its old relationship with crude oil. There is no doubt that the compromise the company accepted — paying royalty on its 70% share of crude oil and paying cess without protest — will impact its profitability. However, the 15% fall in its share price since July this year has already captured the negative news.
A Nomura research report on August 26, when Cairn was trading at . 252 mentioned, “By our estimates its current stock price factors in a long-term oil price of only $60 per barrel.” Extending this logic its Wednesday’s closing price will factor oil price of around $67 per barrel.
Brent crude oil at $105 per barrel on Wednesday trades nearly 40% higher since August ’10, while the scrip trades 15% below. This makes a case for it to play a catch-up in the near future and make up for the lost ground. The regulatory approvals and ONGC’s support will also enable the company to stick to its development plans for the Rajasthan fields necessary to increase production.
A recent report by Goldman forecast a growth of Cairn’s production volumes by 2x between FY11 and FY14E and estimated Rajasthan gross oil volumes to reach 175,000 bpd by March ’12.

Diamond Power Infrastructure (DPIL): Diamond Power to Gain from New Contracts, Expansion

Diamond Power to Gain from New Contracts, Expansion

Co’s RoCE above 18% signals it can create value for shareholders

Recent contracts awarded by power sector majors — NTPC and Power Grid Corporation — are likely to mark the end of the drought in new order flows for mid-sized power equipment makers. 

As more such contracts get awarded, integrated turnkey contractor in power transmission and distribution Diamond Power Infrastructure (DPIL) could be a potential winner.
Diamond Power’s stock valuation has dipped to a multi-year low level, following two consecutive quarters of stagnating performance. In the half year ended June ’11, the company’s revenues grew 5.2% while net profit inched up 2.3%. This was in sharp contrast to the previous half-year period during the July-December 2010 period, when its profits zoomed 86% on a 90% revenue growth.
The scrip, which has lost more than half its worth during the past one year, is now trading at a priceto-earnings of 3.2.
At the end of June ’11 quarter, Diamond Power was sitting on a comfortable order backlog worth . 1,500 crore, most of which will be executed within FY12. This is nearly 45% higher over its revenues from the corresponding nine-month period from last year. And it expects to win further contracts in the near term. The company has recently set up capacities to manufacture
transmission towers, extra high voltage cables and power transformers. It has also entered into strategic JVs with Utkal Galvanizers, Skoda India and Schaltech Automation to increase capabilities for larger EPC projects. All these efforts will enable it to move up the value chain while managing costs better.
The company’s debt has almost doubled between FY09 and FY11. Still, its debt-to-equity ratio remains low at 0.85. The company earns a return on capital employed (RoCE) above 18%, which remains above its cost of debt at close to 13%. This means it will be able to create value for shareholders after servicing its debt obligations.
In spite of its poor stock market performance, the company has been a hit with foreign investors which is reflected in the fact that in the past five quarters, FIIs have doubled their stake in the company to 12.72% as of end-June ’11 from 6.63% as of end of FY10. 

Lead Story: ON THE BEATEN TRACK

ON THE BEATEN TRACK

Any one can fly high when the going is good. But the real stars are the ones who can take the rough with the smooth, who can weather a storm, and live to tell their story. India Inc has spawned many shooting stars only to see them fall by the way side. Trouble has eventually caught up with those charging ahead with overambitious plans, and in some cases, unsound business models. Inevitably, investors taken in by their heady promise have lost money. ET Intelligence Group turns the spotlight on a few such companies which are facing a rough time, for now

“Only when the tide goes out do you discover 

    who’s been swimming naked”
    —Warren Buffett 

    Anyone who is watching the global political and economic events today would be left in no doubt that the tide has certainly and decisively turned. What the economists and governments all over the world wanted the investors to believe, say, six months back can at best be called ‘wishful thinking’. If only wishes were horses. In fact, there is every indication that the trouble is not even half over and the tide is likely to ebb further.
Whether one should invest in such market conditions is debatable. There are some experts who strongly believe that India’s better economic growth conditions could act as a magnet for overseas investments. Retail investors are urged not to desert the market completely as they could miss out when the uptrend begins. 
Whatever course the markets take over the next few months, investors should make sure they don’t end up with those, whom the Sage of Omaha would be glad to term as ‘swimming naked’.
A number of Indian companies are saddled with high debt and have low operating profits in relation to their interest obligations and, in some cases, negative cash flows. In such a compromising situation, they need a high tide to swim without being pointed out. However, they are the first ones to suffer when the going gets tough.
Life has become tough for this lot, as interest rates have gone up substantially over the last 12 months. High interest rates and a high debt pile means companies need to dole out a bigger sum every month towards interest. On the other hand, a weaker economic outlook means their profits will — if not already — face pressure. Top this up with the current conditions in the equity market that prevent any equity dilution plans to ease their pain. In the face of these adversities, companies are trying every trick in the book. Entrepreneurial ingenuity is working overtime to make ends meet. Some are trying to divest non-core assets in a bid to raise cash. A few are borrowing overseas where interest rates are still benign while others are wooing private equity investors or trying to list subsidiaries.
Needless to say, all these measures are shortlived. What is needed the most is a robust business model that can bring in sufficient internal accruals to take care of current debts and fund future growth.
Many of these companies had enjoyed high valuations when all was well, mainly because then they proved difficult to distinguish from the fast-paced growth stories. Now that their vulnerability has become visible, investors should be wary of taking on any bets lured by their low valuations, unless they fix their cash-leaking business models.
ET Intelligence Group lists a few such companies, which are finding the going to be tough at present. 
Debt-Equity Ratio (DER) This shows the relationship between the money that owners and lenders invested in the business. Owners can wait for returns on their investment, but lenders don't. Hence, excessive debt in relation to equity increases risk. 
Interest Coverage Ratio (ICR) This is a gauge of how easily a company can meet its interest obligations. Profit before interest and tax is divided by the interest obligation to arrive at this figure. Higher the interest coverage ratio, easier it is for the company to service its debt and vice versa. 
Pledged Shares Promoters may pledge the shares they hold in the company as a guarantee for loans the company takes. A sharp fall in their value could prompt lenders to sell those shares and recover their dues if no additional guarantees are offered. 
Operating Cash Flows This shows how much cash a company’s business generated during a year. If this is lower than its interest and debt repayment obligations during a year, it will need to borrow more to repay. All tables are based on FY11 numbers except Pledged Shares (%), which is at June 2011 end 


India’s largest drilling rig owner Aban Offshore continues to reel under the huge debt burden it raised to acquire Norwegian company Sinvest in FY07. The $3.3-billion debt was restructured in FY10 to extend the repayment period providing it breathing space at a time when the drilling market globally had slowed down. 
After low repayments in FY10 and FY11, the company will have to repay nearly 3,000 crore of debt in FY12. In addition, the estimated interest cost for FY12 works out to another 850 crore. Meeting these obligations appears to be a tough call in view of its dwindling cash flows. In FY10, the company had raised 700 crore through a preferential allotment. It recently sought shareholder approval for raising $400 million in overseas funding and 2,500 crore through a preferential allotment to qualified institutional investors. However, the crash in its share value in the last one year makes this an unattractive option for promoters.


Hyderabad-based Gayatri Projects has faced a slowdown in many of its construction projects due to the political uncertainty in Andhra Pradesh over the Telangana issue. Out of its 7,000-crore order book, half the projects are located in Andhra Pradesh. The company has amassed huge debt and servicing it is taking a toll on its profitability. Its plans to raise equity through preferential allotments did not take off due to poor market conditions. 
It is now proposing to come out with a rights issue, which awaits clearance from SEBI. In FY11, the company’s operating cash flows fell short of its interest commitments. Gayatri has won a few projects of late, but they will need further funding from the company.

Aggressive investments in creating telecom tower infrastructure that failed to attract higher utilisation have resulted in a mounting debt problem for GTL. This has made investors jittery over the viability of GTL’s business model. The stock has lost four-fifth of its worth in the last five months. This could have serious ramifications since a chunk of the promoters’ shares are pledged. 
The company ended FY11 with nearly 1,300 crore of cash and positive cash flows, which means meeting interest obligations may not be a big concern. However, repayment of its debt will be a key challenge. 
For example, nearly 1,020 crore of FCCBs will need to be redeemed in November 2012, if the share price doesn’t move above the conversion price of 53 from the current 14. GTL is looking at debt restructuring and sale of stake in its subsidiary. The company’s future viability depends on how quickly it can close such deals.


A delay in government’s subsidy payments has resulted in Jain Irrigation borrowing heavily to fund its working capital needs. Nearly half of its revenues comes from sale of micro-irrigation systems to farmers, which enjoy over 50% capital subsidy from the government. 
At the end of March 2011, the money locked in Jain Irrigation’s working capital stood at par with its cumulative investment in fixed assets since its inception. With growing debt and rising interest rates, the company’s interest burden in FY11 was higher than its operating cash flows. 
The company is planning to float an NBFC, which can finance its customers in future and deleverage its balance sheet. The company is holding back on plans to raise funds through the issue of equity or quasi-equity instruments as its share price continues to languish below the comfort level. Still, we consider it ‘low risk’ because its debtors primarily consist of the government


With 2080 MW of running capacity and a further 5300 MW under construction, Lanco Infratech invested 3,400 crore in an Australian coal mine with a view to safeguard its fuel linkage. 
Its balance sheet, already leveraged due to a huge capital work-in-progress, was further stretched due to this. The company’s debt-to-equity ratio as on March 31, 2011, was 3.8 against an industry average of 2.5. 
On the other hand, factors like project delays, falling tariffs and costlier fuel have hampered its profitability and cash generation. For FY11, its interest coverage ratio stood at 3, which fell to 2.6 in the June quarter. The company plans to list its power business in future.


Full-service air carrier Kingfisher Airlines has been a cash guzzler from day one. During the 10-year period FY01 to FY10, it has lost over 3,500 crore. 
The company’s problems emerged mainly as its high-cost model couldn’t break even against the competition from low-cost carriers. The economic slowdown in FY09 added to its woes. 
The company underwent a debt restructuring exercise in FY11 that brought down its debt levels. Its plans for a GDR issue have gone for a toss in the weak market conditions and it is now contemplating a rights issue to shore up its equity. High fuel prices and stiff competition means it is still some way from making cash profits.


Ackruti City is one of the most highly-leveraged real estate players today. Rising debt and higher interest costs are taking a toll on its earnings. Interest cost alone amounted to over 30% of its FY11 net revenue, which jumped to over 54% in the June quarter. Stagnating profits and negative cash flows in FY11 have exacerbated the problem. After a healthy period that lasted the second half of FY10 and the first half of FY11, the company has seen sales and profits dwindling heavily in the last three quarters. The company has several residential and commercial projects scheduled to be completed in 2012, which could offer some support going forward.


JSL Stainless is one of the several steel makers that borrowed heavily to fund massive capacity additions in the last few years. However, with steel demand slowing down and raw material prices staying strong many producers are considering cutting down production. This scenario is detrimental to JSL Stainless as its debt is more than three times its equity with low interest coverage ratio. Moreover, cash flows from operations have not been very high. Near-term profitability is likely to suffer as interest rates are expected to remain high and production is likely to decrease. Though the company expects to come out of its corporate debt restructuring plan ahead of schedule, this would also mean its borrowing costs would rise. At the same time, the company has planned capacity addition at Kalinga Nagar, Orissa, with an investment of about 6,000-7,000 crore. It will be at least a couple of years before the benefits from this expansion start flowing in.


A slowdown in the progress of its irrigation projects in Andhra Pradesh and some hydropower projects has led to problems mounting for Patel Engineering. With cash flows from its ongoing projects drying up, it had to fund other projects through short-term borrowing. However, in the last one year the situation has gone from bad to worse. Till FY10 it had five consecutive years of negative cash flows from operations. Obviously, this means it had to borrow more to meet its interest obligations. The company’s woes have increased as it has failed to bag any major project in 2011 so far, while its 600-crore Lahori Nagpala hydropower project was scrapped.


Heavy initial investment and aggressive marketing plans resulted in Reliance Communications (RCOM) amassing a bulk of its debt over the last few years. A higher amount of debt in absolute terms itself need not raise an alarm given the capital intensive nature of the telecom sector. But what could cause concern for RCOM is its higher debt in the face of falling profits. The company has reported a sequential drop in net profit for the past eight quarters. If this continues, servicing the debt could prove to be a challenge. 
The company is in talks with global funding agencies to restructure its debt portfolio. It recently obtained an underwriting facility for over 8,700 crore from the China Development Bank. It is also looking at a part-sale of its stake in its telecom infrastructure subsidiary. Such arrangements may reduce the impact of higher debt in the long term.


Suzlon Energy acquired its bunch of debt through costly acquisitions and debtor trouble. Net losses at consolidated level in FY10 and FY11 have only worsened matters. The company is grappling with not only high interest costs, but also repayment of the principal amount. Although its consolidated operating cash flows were positive for the last couple of years, they fell short of its annual interest and debt repayment obligations. Suzlon’s acquisition of REpower, which has substantial cash balances, has improved its liquidity condition. However, this has increased its exposure to Europe, which is facing the threat of an economic slowdown. The company has been consistent in getting orders and has amassed a 29,000-crore order book. Its proposed stake sale in Hansen and recovery of a huge sticky debt from a US customer will be key to its successful turnaround.


High-cost overseas acquisitions in FY06 and FY07 and losses on derivative bets have left Wockhardt with huge debt pile. It underwent debt restructuring and sold parts of the business in a bid to weather the storm. Although the debt burden is high, the company’s core business appears to have turned around. After a couple of years of low cash flows, its FY11 operating cash flows were higher than the interest payments. Also, it posted a net profit in FY11 after three consecutive years of losses. Its earnings have further improved in the June 2011 quarter. The company also recently found a suitor for its nutrition business for around 1,200 crore. But the ongoing litigation to wind up the company remains a drag on its share price. Thanks to the improving cash flows from its core pharma business, we regard this company as ‘low risk’.

ON THE BEATEN TRACK

Any one can fly high when the going is good. But the real stars are the ones who can take the rough with the smooth, who can weather a storm, and live to tell their story. India Inc has spawned many shooting stars only to see them fall by the way side. Trouble has eventually caught up with those charging ahead with overambitious plans, and in some cases, unsound business models. Inevitably, investors taken in by their heady promise have lost money. ET Intelligence Group turns the spotlight on a few such companies which are facing a rough time, for now

“Only when the tide goes out do you discover who’s been swimming naked”     —Warren Buffett 

    Anyone who is watching the global political and economic events today would be left in no doubt that the tide has certainly and decisively turned. What the economists and governments all over the world wanted the investors to believe, say, six months back can at best be called ‘wishful thinking’. If only wishes were horses. In fact, there is every indication that the trouble is not even half over and the tide is likely to ebb further.
Whether one should invest in such market conditions is debatable. There are some experts who strongly believe that India’s better economic growth conditions could act as a magnet for overseas investments. Retail investors are urged not to desert the market completely as they could miss out when the uptrend begins. 
Whatever course the markets take over the next few months, investors should make sure they don’t end up with those, whom the Sage of Omaha would be glad to term as ‘swimming naked’.
A number of Indian companies are saddled with high debt and have low operating profits in relation to their interest obligations and, in some cases, negative cash flows. In such a compromising situation, they need a high tide to swim without being pointed out. However, they are the first ones to suffer when the going gets tough.
Life has become tough for this lot, as interest rates have gone up substantially over the last 12 months. High interest rates and a high debt pile means companies need to dole out a bigger sum every month towards interest. On the other hand, a weaker economic outlook means their profits will — if not already — face pressure. Top this up with the current conditions in the equity market that prevent any equity dilution plans to ease their pain. In the face of these adversities, companies are trying every trick in the book. Entrepreneurial ingenuity is working overtime to make ends meet. Some are trying to divest non-core assets in a bid to raise cash. A few are borrowing overseas where interest rates are still benign while others are wooing private equity investors or trying to list subsidiaries.
Needless to say, all these measures are shortlived. What is needed the most is a robust business model that can bring in sufficient internal accruals to take care of current debts and fund future growth.
Many of these companies had enjoyed high valuations when all was well, mainly because then they proved difficult to distinguish from the fast-paced growth stories. Now that their vulnerability has become visible, investors should be wary of taking on any bets lured by their low valuations, unless they fix their cash-leaking business models.
ET Intelligence Group lists a few such companies, which are finding the going to be tough at present. 
Debt-Equity Ratio (DER) This shows the relationship between the money that owners and lenders invested in the business. Owners can wait for returns on their investment, but lenders don't. Hence, excessive debt in relation to equity increases risk. 
Interest Coverage Ratio (ICR) This is a gauge of how easily a company can meet its interest obligations. Profit before interest and tax is divided by the interest obligation to arrive at this figure. Higher the interest coverage ratio, easier it is for the company to service its debt and vice versa. 
Pledged Shares Promoters may pledge the shares they hold in the company as a guarantee for loans the company takes. A sharp fall in their value could prompt lenders to sell those shares and recover their dues if no additional guarantees are offered. 
Operating Cash Flows This shows how much cash a company’s business generated during a year. If this is lower than its interest and debt repayment obligations during a year, it will need to borrow more to repay. All tables are based on FY11 numbers except Pledged Shares (%), which is at June 2011 end 

India’s largest drilling rig owner Aban Offshore continues to reel under the huge debt burden it raised to acquire Norwegian company Sinvest in FY07. The $3.3-billion debt was restructured in FY10 to extend the repayment period providing it breathing space at a time when the drilling market globally had slowed down. 

After low repayments in FY10 and FY11, the company will have to repay nearly 3,000 crore of debt in FY12. In addition, the estimated interest cost for FY12 works out to another 850 crore. Meeting these obligations appears to be a tough call in view of its dwindling cash flows. In FY10, the company had raised 700 crore through a preferential allotment. It recently sought shareholder approval for raising $400 million in overseas funding and 2,500 crore through a preferential allotment to qualified institutional investors. However, the crash in its share value in the last one year makes this an unattractive option for promoters.

Hyderabad-based Gayatri Projects has faced a slowdown in many of its construction projects due to the political uncertainty in Andhra Pradesh over the Telangana issue. Out of its 7,000-crore order book, half the projects are located in Andhra Pradesh. The company has amassed huge debt and servicing it is taking a toll on its profitability. Its plans to raise equity through preferential allotments did not take off due to poor market conditions. 

It is now proposing to come out with a rights issue, which awaits clearance from SEBI. In FY11, the company’s operating cash flows fell short of its interest commitments. Gayatri has won a few projects of late, but they will need further funding from the company.

NATURAL GAS SECTOR: Big Cos to Reap Benefits from Pipeline Network

The domestic city gas distribution companies have witnessed an unwavering and growing investor confidence over the past couple of months even though the overall equity markets are in doldrums. Indraprastha Gas (IGL) and Gujarat Gas are both trading higher than the last week of July when the markets crashed.
These firms have emerged as steadily growing companies with robust business model and strong balance sheet. Both these companies are reaping the benefits of widespread infrastructure they created over past several years. Gujarat Gas began its CNG operations in 1992, but IGL, which started operations in 1999, has already overtaken it in CNG volumes, thanks to the government-led impetus to rid the Delhi region of pollution.
Today, both enjoy strong cash flows with over 35% return on employed capital (RoCE), paying regular dividends and reporting double-digit growth quarter after quarter. Still their valuations differ markedly. IGL trades at P/E above 21 while that of Gujarat Gas is around 18. This is despite the fact that Gujarat Gas is bigger in terms of volumes. The reason lies in their risk profiles. A large chunk of the gas that IGL retails has been allotted to it on priority basis and comes at a cheaper rate. In comparison, such prioritised and cheaper gas makes less than 5% of the sales of Gujarat Gas. Similarly, 82% of IGL’s sales are to CNG vehicles where passing on costs is relatively easier compared to Gujarat Gas, which sales over 80% to industrial customers. In comparison, the bigger companies in the natural gas transportation business Gail and Gujarat State Petronet (GSPL) have not done as well in the recent turmoil. Both are setting up large pipeline network. However, the infrastructure will be optimally utilised only after availability of natural gas in India improves over the next few years. With RIL’s KG Basin output staying considerably below the expected levels, future growth upplies is being viewed with greater scepticism.
The premium valuations of the city gas distributors appear justified, but at the same time are too high. Long-term investors should, therefore, do well to prefer the larger players that will benefit as their growing pipeline network starts getting gas.

KEMROCK INDS: Building a New Composite to Drive Business

The increasing demand for Kemrock’s fibre-reinforced plastics (FRPs) and its successful foray into carbon fibre will prove key growth drivers for the company in coming quarters. In spite of a leveraged balance sheet and low promoter holding, the company’s steady share price in the latest market crash has proven its mettle. Long-term investors should accumulate the scrip.

BUSINESS
After being the leader in plastic composite products for several years, Kemrock Industries has also become India’s first company to manufacture carbon fibre on a commercial scale. The company makes a large variety of products using FRPs or plastic composites. These find application across industries such as windmills, aerospace, petroleum, mass transport and infrastructure. The FRPs are better performing substitutes for traditional materials such as metals, wood, concrete and glass and are predominantly consumed in developed countries. As a result, more than twothirds of Kemrock’s revenues come from exports.

GROWTH DRIVERS
Kemrock recently commissioned its first carbon fibre plant, which will be doubled to 800 tonne per annum in FY12. Once the company gets all the quality approvals for carbon fibre and starts supplying to aerospace industry its revenues and profits will jump substantially. It has acquired an 80% stake in Italy-based Top Glass, which manufactures a variety of composite profiles. It has also tied up with Netherlands-based DSM Composite Resins for production of specialty composite resins in India.

VALUATION AND CONCERNS
Kemrock’s net profits tripled from 25 crore in FY08 to 75.5 crore in FY11. Its return on capital employed (RoCE), which fell steadily from 16.5% in FY08 to 8.4% in FY10, improved to 11.5% in FY11.
Although the business is growing well, the company needs to fix a few things. In its bid to achieve highspeed growth it has raised huge debt and diluted equity often. Its debt-equity ratio of 1.6 at the end of June 2011 was the lowest in five years, but needs to come down further. The promoter's holding in the company has dropped to 28.5% of which over 61% shares are pledged. Still US-based RPM International, which controls 18.2% stake in the company, recently made an open offer at 539 for 20% stake.

RELIANCE INDUSTRIES : Uncertainty Over, Now for Some Sebi Respite

The recent underperformance of the Reliance Industries stock had less to do with the profitability of its businesses or growth prospects and is more related to uncertainties surrounding certain some legal issues. The Comptroller and Auditor General’s (CAG) report on the company’s KGD6 block was one of them. Although the CAG’s report makes a series of comments which are adverse to RIL, what is good is that the uncertainty is now over on this front.
This was evident in the way the stock reacted on Thursday. RIL was down close to 2% at one point during the day after the CAG’s report was tabled in Parliament. However, a press release from the company, which can at best be described as generic, helped breathe fresh life into the scrip, helping it end the day with gains of over 2.5%. RIL has said that it can’t comment on the CAG’s final report, as the company had not viewed it.
The CAG’s report had proved to be a drag on RIL’s valuations, mainly because it affects the company’s flagship KG-D6 project, which it had been marketing as a global benchmark for effective, efficient project completion and capital cost competitiveness. In fact, RIL had already fought a long and tiring legal duel with ADAG over the same KG-D6 block. The allegations of ‘gold-plating of the costs’ raised at a time when the two groups were battling each other had prompted the petroleum ministry to order a CAG probe. Interestingly, CAG’s final report didn’t stress on this issue much, although it sought in-depth review of 10 high value contracts. This could be an indication that the company’s earlier response to the CAG appears to have had an impact. The CAG’s key observations and recommendations do still appear daunting. If the production-sharing contracts and profit-sharing mechanism come in for an immediate review, it could mean the company’s profits from sale of oil and gas could come down substantially. However, every company has to routinely fight several legal battles while running its business and this is likely to end up as just another battle.
The other key uncertainty weighing over RIL’s market performance is its brush with Sebi. For almost two years, RIL has been attempting to work out consent terms in two cases with the securities market regulator — over breach of insider trading norms in 2007 and breach of creeping acquisition norms in 2000. Investors need to watch out for these cases too.

REFINING INDUSTRY: Weak Re to Translate into More Profits for Local Cos

At a time when many industries are facing margin pressures, the global petroleum refining industry is doing well now with healthy margins. Gross refining margins or GRMs — the difference between the selling price of refined products and crude oil required to produce them — have improved during the September ’11 quarter from the June ’11 quarter in spite of oil prices staying high. Removal of customs duty on petroleum products signals that the benefit to Indian standalone refiners would be less.
The Refining Marker Margins (RMM), a generic indicator published by BP every week rose to $13.98 per barrel in the September quarter, which is the highest in almost three years. The Singapore-Dubai crack margins quoted by Reuters moved up from $7.91 / barrel in July to $10.04 in August. “Singapore GRMs improved significantly in August due to a significant improvement in spreads,” a monthly update report from B&K Securities said. According to the International Energy Agency, the June quarter saw Chinese refineries working at lower-than-expected capacity level, which is likely to continue in the September quarter. End-July, a refinery in Taiwan with a capacity of 540,000 barrels per day was shut down reducing regional supplies.
India cut the customs duty on crude oil and petroleum products in end-June this year to bring down under-recoveries of stateowned refiners and exploration firms. A reduction in customs duty lowers the duty protection enjoyed by refineries. As a result, the benefits of a rise in global refinery margins is likely to get somewhat diluted when it comes to domestic standalone refiners. Companies such as Reliance Industries, Essar Oil and Mangalore Refinery are expected to post refinery margins in line with their June quarter numbers.
The weakness in the rupee is, however, going to play in favour of domestic refiners. The Indian rupee weakened to 46 against US dollar in the first week of September ’11 from an average of 44.7 for the June ’11 quarter. This means every dollar of refining margin will translate into more profits in rupee terms.
The September quarter outlook for domestic standalone refiners — RIL, Essar Oil, and MRPL—appears robust, with their profitability staying on par or above that in June ’11 quarter.

ONGC: Investors Can Wait to Buy in ‘Discounted’ FPO

All analysts tracking it have a strong ‘buy’ call on it, but that didn’t prevent India’s largest oil producer ONGC from underperforming in the past three trading sessions, even as the broader equity market recovered. It was ironic since the company had held its ground for more than a month, when the broader market was tumbling. Interestingly, it was the news of its long-awaited follow-on public offer (FPO) that caused a selloff.
ONGC’s FPO has been talked about for almost a year now and was postponed at least twice before. In February ’11, the company also issued 1:1 bonus shares and halved the face value to . 5 in a bid to make its shares more affordable to retail shareholders. Still, the share price has not gone up anywhere since then. For investors, if an FPO is just round the corner, which in all probability will be priced at a discount to the market price, it makes little sense to buy the shares from the open market. They would rather wait and buy in FPO at a discount. This is what caused a 4.3% fall on Tuesday. Investors have been avoiding the company for more than three months now. Since May 2011, the average monthly turnover in the ONGC scrip has steadily declined. For August, the average turnover in the scrip was less than half of that in May. The price that the government sets for the FPO will be disclosed just a couple of days prior to the opening of the issue, which should happen sometime in September. However, that leaves little time to straighten out the key issue of subsidy sharing. Moving on to a formula-based subsidy sharing rather than the current ad-hoc system was considered essential for obtaining a better valuation at FPO. In its absence, the government will have to settle for a compromise — lower pricing.
Nevertheless, the second problem that needed to be fixed before FPO has been solved favourably. The Cairn Group has indicated that it will submit to all government covenants and share royalty burden with minority partner ONGC for Rajasthan’s oil fields. This certainly has a positive impact on ONGC’s future earnings.
If fundamental analysts held the company undervalued earlier, it was more so after the recent fall. A flat share price since February means even the potential benefits of reduced subsidy burden in Rajasthan haven’t been priced in yet. In other words, ONGC’s FPO has every reason to be successful whenever it opens.