OIL & GAS SECTOR: Regulatory Action may Catalyse Future Growth

India’s petroleum sector was the unwanted child for much of 2012, but there is light at the end of the tunnel for the sector as the government shakes off its inertia and shows signs of addressing its problems. Investors, though selective, are turning bullish as the government appears to be moving towards market pricing of petro products, though total decontrol may be years away.
In 2012, the BSE Oil & Gas index rose 10%, underperforming the 25% gain for the broader benchmark BSE Sensex. Much of this underperformance was due to policy inaction-induced bleak earnings outlook. It is changing now. The petroleum ministry is expected to make headway on the long-standing issues regarding E&P capex approvals for Reliance Industries and Cairn India. The Rangarajan Committee on pricing of gas is supposedly recommending linking of price to international benchmark such as Henry Hub in the US, or imported liquefied natural gas prices. If done, it improves the earnings outlook for explorers such as RIL and Cairn.
“In our recent interaction, government officials sounded more positive and indicated that the pace of decisionmaking has improved. DGH is working towards improving the attractiveness of Indian E&P, while PNGRB is trying to bring in more transparency,” cited a report from Motilal Oswal in mid-December. The research house expects this to be positive for RIL and Cairn.
The government had constituted a committee under the chairmanship of C Rangarajan, chairman, PM’s Economic Advisory Council on May 31, 2012, to look into the design of future production sharing contracts in hydrocarbon and suggest guidelines for pricing domestically produced gas.
“Beyond 2014, we expect to see a review of pricing terms. Currently, our only producing block KG-D6 offers gas at $4.20 per mmbtu, which will remain in force till April 2014. Based on current alternative LNG import pricing, and recognising that a competitive pricing framework is essential for domestic development activity, we see considerable scope for a more market-linked gas pricing regime to prevail post 2014,” said Bob Fryar, executive VP, production at BP Global, at an upstream investor day earlier this month. BP holds 30% stake in the KG-D6 block operated by Reliance.
ABarclays report on the oil & gas sector highlighted that the natural gas prices could rise with a decision on KG-D6 price revision likely in FY14. This will be a positive for ONGC and Oil India, besides RIL.
A few foreign brokerage houses such as UBS and CLSA have turned positive on Reliance last month on hopes of resolution of regulatory issues and gas pricing. It may be still too early to forecast how the government regulations would shape up. But any govt action could only be positive from where it was for the last few years.

OMCs Set to Float 3,500-cr Global Tender for Ethanol

Public sector oil marketing firms are readying to jointly float a . 3,500-crore global tender to source ethanol, which will have to be mandatorily blended with petrol sold across the country following the government’s directive. Officials of Indian Oil, BPCL and HPCL, the three state-run oil marketing firms, and the oil ministry will be meeting over the next few days to finalise the details of the tender, a person familiar with the matter told ET, adding that the industry will need about 1,000-1,100 million litres of ethanol a year.
The success of the tender is expected to determine the feasibility of the pan-India rollout of the 5% ethanol-blended petrol programme, which is already functional in 13 states. The government had postponed the deadline for the nationwide roll-out of the programme to June 1, 2013 from December 1, 2012.
Since the oil marketing companies are not in a position to take care of the infrastructure needed to import, store and transport the material, the tender will involve delivery at their depots numbering more than 350 across the country. 
Hindustan Petroleum had, through its wholly-owned subsidiary HPCL Biofuels, acquired two sugar mills in Bihar that it revived in the previous fiscal. These units can supply nearly 32.5 million litres, about 10-12% of the company’s annual ethanol requirement.
The three firms had attempted to source ethanol directly from the world’s biggest producer, Brazil, in 2006, when the blending programme was introduced subject to commercial viability. Between 2006 and 2009, these companies floated tenders to procure the necessary quantities of ethanol. “Our experience during those three years was that the contracted volumes were always lower than the requirement and the actual supplies would fall short of the contracted volumes,” said an official, who did not wish to be named. In 2009, the process changed with the government fixing the price at . 27 per litre. These companies had to float EoI for the quantities needed, which led to an improvement in the contracted volumes and supplies.

PETRONET LNG: Kochi Unit May Take a While to Ramp Up

The stock of India’s largest importer of natural gas, Petronet LNG, lost close to 1% on Wednesday on reports that the commissioning of its Kochi terminal will miss the deadline of the last quarter of FY13. This may not be a major setback for the energy major, as the ramping up of the project for the future was already in limbo due to lack of pipeline connectivity and customer base.
Petronet LNG’s 5 million tonnes per annum (MTPA) unit at Kochi is in addition to the 10 MTPA plant at Dahej. The Kochi unit was to begin commercial operations in the quarter to March 13. This is now facing some delays.
At the . 4,200-crore Kochi plant, regassification tariff will be higher than the $0.65 per million British thermal units (MMBTU) at Dahej. The company had mentioned in its annual report for FY12 that it has already tied up 1.5 MTPA of short-term LNG supply for the Kochi project. Supply of 1.44 MTPA of LNG from Australia’s Gorgon project on long-term contract will begin in 2014.
However, capacity utilisation at the new plant will remain below par for a few quarters post commissioning since the pipelines connecting it to key consumption hubs of Bangalore and Mangalore are delayed. “Initial volumes are likely to be low due to lack of a developed customer base and pipeline connectivity delays,” said a Credit Suisse report in October.
High LNG prices are affecting consumer interest too. NTPC’s Kayamkulam plant (potential consumption of approx 1.2 MTPA) has is not ready to sign a PPA at the current price, according to a recent report from Karvy Stock Broking. Also, Gail, which is laying the pipelines, is facing public resistance at different places along the route.
The Karvy report said that out of the optimal capacity of 5 MTPA, volume visibility is limited to 1 MTPA at Kochi. Sub-optimal use of capacity will mean undue burden on the company’s financials. 

ONGC’s Foreign Acquisitions may not Find Street Support

 ONGC’s overseas arm ONGC Videsh, or OVL, has been on a shopping spree abroad. On Monday, it announced a $5-billion acquisition in Kazakhstan, following up on a $1-billion acquisition in Azerbaijan in September. These deals may be in line with its long-term strategy, but may not necessarily support the ONGC’ stock which has been languishing.
According to Sandeep Randery, head of research of BRICS Securities, OVL’s proposed $5-billion acquisition is front-loaded. The company, he says, has paid upfront for the asset that will start generating substantial cash flows only from 2016 onwards. However, the interest meter will start ticking immediately.
For the $5-billion deal, OVL will be paying ConocoPhillips, it will get an 8.4% stake in the highly prospective Kashagan field that holds an estimated 30 billion barrels of petroleum reserves, of which close to 12-13 billion are potentially recoverable. The field will commence production mid-2013 at 75,000 barrels per day, or bpd, which can be ramped up to 300,000 bpd by 2016 in the first phase. In the second phase of development, production is projected to top 1.5 mbpd by 2021, which has not been approved yet.
The projections may look grand, but the deal, if approved, will empty the company’s coffers, which held net cash of $2.3 billion at the start of this fiscal. “ONGC has used available cash and has committed long-term capital to a still uncertain large development (phase 2) and which will add little to its overall production in near term,” said a Credit Suisse report.
ONGC has long been facing a steady decline in its production, even though it continues to add substantially to its reserves with incremental discoveries.
Even without this acquisition, the funding of its annual capex programme has been a growing concern as operating cash flows fall short due to high subsidies. In FY12, the company posted . 30,600 crore of cash profits after paying . 44,466 crore as subsidies to downstream companies. However, its capital expenditure budget for FY13 is . 33,000 crore, with an equivalent figure for FY14.
ONGC’s domestic oil production business, which by far remains the biggest in its current portfolio, is not adequate to fund these acquisitions or the ongoing capex due to the growing subsidy burden.
Thus, ONGC’s recent buying spree may be good to secure energy sources for the country and meet its long-term production goals, but are hardly relevant to its near-term issues. That is why the buyout may not boost the company’s stock.

RELIANCE INDUSTRIES: Sell Call on RIL at Historic High, But Some Hold a Contra View

Analysts appear to have become the most bearish in three years on Reliance Industries, India’s largest company by market capitalization, according to data compiled from Bloomberg. Most analysts have turned neutral, while ‘sell’ recommendations on the stock are at a historic high. There are brokerages with a bullish view on the company on the back of the recent positive news flow, but retail investors should be cautious in taking a bet on the stock.
Data since 2006 on analysts’ recommendations on RIL shows only 15, or close to 30%, of a total of 49 analysts tracking the company have a ‘buy’ call on it in November. One in four analysts have given a ‘sell’ call, which is unprecedented. Last November, nearly 80% of the analysts had a ‘buy’ recommendation. A similar situation was last seen only between September and December of 2009 when less than 30% of the analysts were bullish on the company with the rest being either neutral or bearish. The RIL stock remained flat over the next 12 months.
But there are some who are betting on an improved external environment, especially at the government level, besides the company’s share buyback programme to make a positive impact. “Reliance agreeing to CAG’s terms of audit of the D6 block should pave the way for some important approvals even as an expert committee submits its recommendations on gas prices by end 2012,” says a CLSA report dated November 22, while pegging the one-year target price at . 850. “While the recent step-up in buyback should support the stock, positive upstream news flow and the launch of Reliance’s broadband businesses are the nearterm news flow triggers,” it says.
The global equity research wing of UBS is also bullish on the company, saying a positive regulatory momentum is building up for it. In its report dated November 22, it listed five key catalysts that will help RIL’s share price move up: 1) formal approvals for MA, D1-D3 revised FDPs (field development plans) with start of workovers; 2) exploration approval at KGD6; 3) GRMs (gross refining margins) staying firm despite volatility and growing shale gas contribution to drive cash flows; 4) efficient cash usage for E&P, LNG; 5) gas price hike post 2014/CBM pricing.” UBS has reiterated its ‘buy’ rating while keeping the one-year price target at . 1,015.
RIL has been hit by falling natural gas output from its KG-D6 block, while the performance of its refining and petrochemical businesses was hit by commodity cycles. The company’s plans to use its huge cash pile for further growth are longterm in nature. This means there is no near-term trigger to improve earnings or prop up the stock price. 

Ethanol Blending may be Easier said than Done

Issues like availability, quality & prices may affect not just oil cos, but chemical firms as well

The chemical industry is miffed about the government’s decision to make 5% ethanol blending mandatory for petrol sold across the country, fearing that it could raise prices of the industry’s basic building block too high. However, people from both petroleum and chemical industries are awaiting further clarity on implementation of the policy to assess its exact impact. Ethanol or ethyl alcohol is a basic raw material for the chemical industry. Ethanol derivatives find use in various industries from agrochemicals, dyes, pigments, paints and additives to pharmaceuticals.
The ethanol-blended-petrol programme, introduced in 2006, has covered 13 states so far and has met with moderate success. In FY12, oil companies used 44 crore litres of ethanol for blending. “The Indian chemical industry was already suffering from rising alcohol prices due to the weak monsoon in Maharashtra and the rupee’s depreciation. The government’s decision (on ethanol blending) would further raise alcohol prices. India’s ethanol production in FY12 was around 230 crore litres, which is expected to come down to 200-220 crore litres in FY13. Of this, around 110-130 crore liters are used by the potable alcohol industry, while the chemical industry will need around 85 crore litres. This means the country will have to resort to imports to meet petrol blending requirements,” said Yogesh Kothari, president of Indian Chemical Council.
“With a compulsory blending programme, ethanol availability to the industrial sector and the potable alcohol industry is likely to get affected unless the supply is increased. Higher demand for ethanol will also result in increased price of molasses,” says Debasish Mishra, senior director, Deloitte in India 
The potable alcohol industry, which enjoys the protection of heavy customs duty on imported spirits, finds it easier to pass on the hike in input costs to the consumer, but it will not be so easy for the chemical industry that competes on a global level.
Not every person in the chemical industry is worried, though. “We are already buying industrial alcohol at . 32 per litre with 95% purity, as against the 99% purity needed for petrol blending. If the prices rise to . 35-36 levels imports will start. This 10-15% cost hike should be manageable for us, since our products are primarily used in life saving drugs,” said Ram Reddy, whole-time director with Balaji Amines, for which ethanol is a key raw material. The government is marketing the ethanol-blended-petrol programme on the grounds that it will help bring down costs and make the fuel greener.
However, the petroleum industry itself is not so enthused with the idea, citing operational challenges. “In spite of the industry’s keenness to implement it (ethanol blending), the progress was limited because of certain ground realities like, for example, unavailability of ethanol in various parts of the country. There has hardly been any change in this,” an official said on condition of anonymity. Even chemical industry sources acknowledge that the petroleum industry has been facing challenges, particularly on 
    consistent quality and taxation. Industry leader Indian Oil had mentioned in its annual report for 2009-10 that lack of availability of ethanol was the main reason for the ethanol-blended-petrol programme not stabilising. “Further, oil marketing companies have been facing certain constraints with respect to free inter-state movement of ethanol and the levy of duties by state governments,” it added. Although the government’s intent is right, how the policy gets implemented would determine its impact on both petroleum and chemical industries. A hasty implementation, without addressing the concerns of both the industries, could end up just disturbing the domestic equilibrium. 

Rising Oil Prices to Leave Govt Fiscally Challenged

India is once again staring at a dangerous concoction of a weak rupee and high international oil prices that could delay any meaningful fiscal consolidation process. The central government’s tax income from the sector has declined, but the subsidy burden continues to remain high.
India’s petroleum sector alone reported an under-recovery of . 85,586 crore — around 60% to be financed by the central government — for the first six months of the current fiscal, as global oil prices stayed firm and rupee remained weak. Hopes for a turnaround had flared when the government took steps in September to rein in the sector’s losses, accompanied with the rupee’s appreciation above 52 against the US dollar and stagnation in global crude oil prices. However, things have once again worsened over the past two months.
From the peak above 52 against the US dollar at end-September, the rupee has steadily fallen to below 55 at present. Meanwhile, crude oil prices have spiked following the unrest between Israel and Palestine.
As a result, India’s cost of importing a barrel of oil has moved above . 6,000 after a gap of two months.
Under-recoveries reported by the three staterun oil marketing companies (OMCs) have gone down from . 551 crore per day in the first fortnight of September 2012 to . 412 crore per day in the second fortnight of November. However, the average for the current quarter so far still remains at par with the July-September quarter. This means the sector’s under-recovery should remain around . 37,000 crore in the October–December quarter in line with . 37,775 crore of the second quarter.
It is no secret that the government is finding it difficult to compensate OMCs. For the first half of FY13, the government agreed to pay just 35% of the . 85,586 crore under-recovery. This was much lower than the typical 60% it had paid in the earlier years. Factors such as delayed divestment process due to weak capital markets and poor receipts from the recent 2G auction are compounding the problems.
At a time when the industry’s under-recoveries are growing, reduction of taxes has brought down the central government’s income from the sector. In June 2011, the government had cut customs duty on crude oil and products and excise duty on diesel, which was restored only in September 2012. 

KEY POINTS India’s petroleum sector alone reported an under-recovery of . 85,586 crore
From the peak above 52 against the US dollar at end-Sept the rupee has fallen to below 55 at present
For the first half of FY13, the government agreed to pay just 35% of the . 85,586 crore under-recovery
India’s growing petroleum consumption but stagnating production means the imports are rising

Stronger Rupee Bumps Up Margins, Profits

Net profit grows after four quarters of decline, but revenue growth and higher interest costs a worry

    In a reversal of trend, operating margins and earnings of India’s top companies, led by the steel, tyre, metal and fast moving consumer goods sectors, improved in the quarter to September, buoyed by a stronger rupee last quarter, which helped stem foreign exchange losses and boost profits. However, what is worrying is slowdown in revenue growth, higher interest costs and increased leveraging. An ETIG analysis of 2,300 companies, excluding banks, financial firms and oil marketing companies, based on data for 13 quarters, shows a turnaround in corporate profitability and operating profit margins. India Inc’s operating profit margins improved to 14.5%, which was thehighest in the past five quarters. Net profit for the quarter rose 25% year-on-year — the highest in the past two years and a welcome break after four consecutive quarters of slide. However, it may be too early to cheer considering that the earnings were boosted because of a strong rupee during the past quarter. The Indian rupee rallied strongly to 52 against the US dollar at the end of the September 2012 quarter — up from 56 at the start of the quarter — helping local companies to cut their forex losses. This took a chunk off other expenditure, boosting operating profits. Since then, the rupee has started sliding and was 55 to the US dollar last weekend.
The latest earnings figures confirm a few worrying trends from the recent past. The growth in net sales, at 10.4%, was the slowest in the past three years, while other income – income from non-core business activities – still constitutes over onefourth of pre-tax profits. And to boot, India Inc’s leveraging has risen during this period. An analysis of half-yearly statement of assets and liabilities published by 1,608 companies, excluding banks and finance, shows that India Inc’s net debt to equity rose to 0.44 at end September 2012 from 0.4 at end March 2012. This was because of a 14.2% rise in net debt, compared to a rise of 4.4% in net worth during the same period. This is also reflected in high interest costs, which ate into 3.4% of net sales revenues – slightly higher than the average for the preceding four quarters. What is also worrying for Indian companies is the macro economic backdrop. Inflation continues to be high — 7.45% in October — dampening the prospects of a possible rate cut, while factory output slipped to 0.4% in September, indicating a contraction in economic activity. The finance minister has scaled down the GDP growth forecast for FY13 to 5.5%, which will be slowest since FY03.
The quarter’s revival in earning numbers was led by sectors such as tyres, steel, metals, mining and minerals, cement and cement products, FMCG, Infotech and power generation. Similarly, the aggregate numbers of smaller industries, such as hospitality, laminates and plywood, agrochemicals, petrochemicals and tyres, were also better than the past few quarters. Sectors such as paper, sugar, solvent extraction and ferro-alloys reported a return to profitability, compared to a loss in the September 2011 quarter. However, the troubles for sectors such as capital goods, real estate and construction, automobiles and telecom continue, given their under-performance, impacting profitability.
What has been heartening is the fact that outbound corporate M&A deals have picked up pace after the lull of 2011 and first half of 2012. Outflows from India, the dominant source of FDI from the Asian region, increased from $13.2 billion in 2010 to $14.8 billion in 2011. However, Indian Transnational Corporations became less active in acquiring overseas assets. The amount of total cross-border M&A purchases decreased significantly in all three sectors — from $5.2 billion to $111 million in the primary sector, from $2.5 billion to $1.5 billion in manufacturing, and from $19 billion to $4.5 billion in services.

Subsidy Issues Mean Retail Investors have Little to Gain

IndianOil, BPCL, HPCL were compensated for . 60k cr against under recovery of about . 86k cr

    Three oil marketing companies — IndianOil, BPCL and HPCL — reported profits on Friday for the July-September 2012 quarter, which were way short of covering the preceding quarter’s losses. That the government is facing challenges in compensating these navratna companies is becoming clear from delayed and limited payments, which is raising the debt burden and eroding the net worth for these three companies.
The three oil marketing companies together had reported a total under-recovery of . 85,586 crore for the April-September 2012 period. However, they were compensated only for . 60,160 crore. This meant nearly 30% of the under-recovery had to be absorbed by the marketing companies. IndianOil had to absorb . 13,635 crore of under-recoveries, while BPCL absorbed . 6,133 crore.
In other words, the profits from the second quarter were insufficient in compensating for the losses of the April-June quarter. IndianOil, the biggest of them, reported a net profit for the September 2012 quarter — thanks to the . 16,094 crore of government grant towards the April-September period. It had posted a net loss of . 22,450 crore in the first quarter.
The government’s support for the first half year barely at 35% of the industry’s total under-recovery was at par with the burden borne by upstream companies like ONGC, Oil India and Gail.
This reflects a sorry state of affairs where the government’s ability to compensate oil companies for their losses has gone down substantially. IndianOil’s net worth — total shareholders’ funds —has reduced 22% in thepast six months to . 45,041 crore as a result of these losses.
Ongoing cash losses have also forced the company to borrow heavily which has pushed its borrowings up 26% within the last six months to . 88,960 crore at the end of September 2012. The growth in total debt is somewhat lower at BPCL and HPCL as they cut their long-term borrowings during thepast six months.
Although the OMCs will never face the risk of bankruptcy or a shutdown, being governmentowned and strategically important, retail investors cannot expect to make any positive returns from them till the subsidy regime improves.

New Power Plant and Cheaper Funds Likely to Boost Essar Oil

Essar Oil’s September 2012 quarter numbers failed to satisfy the market. The company showed an improvement on some operational parameters, but the bottom line was barely in black. However, things could start improving in the next couple of quarters once its coalbased power plant is commissioned and the company arranges for lowcost foreign borrowings.
Essar Oil posted a net profit of . 105 crore on a turnover of . 21,023 crore. The company operated its refinery at full capacity through the September quarter and increased its heavy oil intake to nearly 64% of the total. This enabled it to post a gross-refining margin of $7.86 per barrel — its best so far. Its operating profit stood at . 1,037 crore against a loss in the year-ago period. 
However, the entire operating profit was wiped out by interest and depreciation costs that together stood at . 1,064 crore. It was mainly . 132 crore of other income that helped it post profit in absence of any taxes. On the other hand, the company’s balance sheet saw a sharp worsening. Its net worth dropped to . 658 crore — lower than a third of what it was just six months ago. A simultaneous increase in borrowings by 26% to . 20,208 crore meant that the debt-equity ratio looked horrible at 30.7 at end-September 2012. Notwithstanding these factors, the management is unfazed.
“Essar Oil’s refinery with 20-mtper-annum capacity and the 11.8 complexity index was built at a capex of . 25,000 crore. A similar refinery today would cost twice that,” said LK Gupta, MD & CEO, Essar Oil. He assured that Essar Oil’s bankers are not in any way anxious about the balance sheet since operating cash flows would be sufficient to meet the debt repayment schedule.
The company will shortly commission its coal-fired power plant, which will reduce the fuel cost for running the refinery, and is planning to raise cheaper external commercial borrowings to part-finance its rupee-denominated high-cost borrowings. Both these steps should push profitability up to a level, where it won’t be dependent on other income. 

KEY POINTS Company showed an improvement on some operational parameters, but the bottom line was barely in black
Things could start improving in the next couple of quarters once its coal-based power plant is commissioned
The company’s balance sheet saw a sharp worsening

ONGC: Rising Subsidy is like a Millstone Around the Neck

ONGC, India’s biggest profitmaking listed company, has reported a 32% slippage in profits for the quarter to September as revenues dropped, costs rose and margins shrank, mainly due to a spurt in its subsidy burden. Moreover, there is no assurance that the state-run company’s subsidy woes will end anytime soon, making the stock unattractive to investors. 
Under the government’s directive, ONGC had to extend . 12,330 crore of discounts to the three public sector oil marketing companies, more than twice the burden in the year-ago period. This led to a 12.4% drop in the company’s net revenues to . 19,885 crore. As a result of the heavy discounts extended, the company’s net realisation from selling each barrel of crude oil dropped 43.4% from the year-ago level to $46.8 a barrel. Its oil production also continued to fall, resulting in an output of 5.1 million tonne during the quarter, down 8.2% compared with July-September 2011. At the same time, the company’s costs increased due to a 20% jump in statutory levies, by far the biggest cost component for the company. A 42% jump in exploration costs and a 66% jump in staff costs made the matters worse. 
The company’s chairman and managing director, Sudhir Vasudeva, mentioned in a post-results press conference that the company’s entire cash reserves could get wiped out “within no time” if the heavy discounts were to continue. The company is working on several high capex projects. ONGC’s performance has been stagnating not only due to its ever fluctuating subsidy burden but also because of a steady decline in output from its ageing oil wells. It has failed to make up for this by the timely commissioning of new fields. 
The company announced a few discoveries during the quarter, as has been its custom for the past several years. However, it is not clear as to when these discoveries would translate into incremental production. 
The company had announced in the recent past that some of its new fields would commence production in the 2013-2015 period, which could address to an extent the concerns over its dwindling output. Nonetheless, the company’s valuation is unlikely to improve in the near term until the ad hoc nature of subsidy sharing is done away with. 

‘Central Banks May Buy 5,000 Tonne of Gold Over 10 Years’

In recent times, high gold prices have put off households and investors. But Aram Shishmanian, CEO of World Gold Council, 
strongly feels that economic uncertainties and wealth destruction that the world witnessed in the last few years can only make gold more relevant. The return of Obama and hopes of another round of quantitative easing has once again pushed up the yellow metal. As the Council tries to convince central banks of the importance of building gold reserves, he toldRamkrishna Kashelkar that investment demand would surge in the days to come. 

How do you see the global gold market today? Globally, gold is undergoing fundamental shifts in the nature of its demand. We are seeing a new relevance to gold emerging. For the past 10 years, central banks over the world were selling gold. They sold some 5,000 tonne over the last decade. Since the last two years, they have started buying gold again because they are reassessing their risk management approach. As you know, the whole crisis in the US and in the Europe was driven by bad risk management. In the next decade, they could be buying back over 5,000 tonne gold or an average 500 tonne per annum. Countries would increasingly prefer holding gold as part of their multicurrency forex reserves. 

So you believe investment demand for gold will grow rapidly? Yes, the investment market will grow dramatically even at the retail level. A few years back, it was just 5% of the market, now it is 40%. Why? People in the US and Europe have lost 20-40% of wealth in the last few years. Hence, people have started looking to hold part of their funds in gold to protect wealth and make sure they don’t stay under-funded for their future. Gold may not be ‘the answer’ to the wealth destruction problem, but it is an important contributor. This is relevant for India as well. If Indians had not protected their wealth all these years through investing in gold, they would be much less wealthy and perhaps even face some of the challenges the Americans are facing today. With increased sophistication of the financial system and suitable policy changes, the demand for gold-linked investment product is going up. Gold demand is shifting from coins or bars to financial products like ETF. 

But aren’t high prices impacting demand? That’s true. Last year, India’s demand for gold stood at . 2.3 trillion or around 980 tonne. This year, it has come down mainly due to factors like devaluation of the rupee against the US Dollar and a relative slowdown in the economy. Gold price had peaked to . 3,400 per gram earlier this year and that has no doubt had an impact on gold demand. Still, considering the most important last quarter is still to go, even in a worst-case scenario, the annual demand is not expected to fall more than 10% from last year’s level. When compared to other discretionary expenditure, gold has done better than anything else in India this year. 

What do you have to say on gold lending in India? Leveraging is a very sound usage of gold and it is good that it is growing in India. Using gold as collateral with no intention to sell it has a real value. In fact, we have been working with European central banks to use their national reserves to guarantee government bonds. This can considerably reduce interest rates. This idea is getting a lot of attention now.

Last year, India’s demand for gold stood at . 2.3 trillion or around 980 tonne. This year, it has come down mainly due to factors like devaluation of rupee against the US Dollar and a relative slowdown in the economy. Gold price had peaked to . 3,400 per gram earlier this year and that has no doubt had an impact on gold demand.
    ARAM SHISHMANIAN
    CEO, World Gold Council

No Dues from Govt Mean OMCs to Post Losses Again

India’s Navratna oil marketing companies — Indian Oil, BPCL and HPCL — are set to report another quarter of heavy losses as they have failed to get compensation from the government for selling fuels below cost.
As a result, the trio will see a further reduction in their net worth to a critical level when they announce their results on November 9.
The three oil marketing companies sell diesel, LPG for domestic use and kerosene through public distribution system at prices that are substantially below their costs, in accordance with the mandate of their majority shareholder, the government of India. 
In return, a small part of their losses is made good by discounts from upstream PSUs like ONGC, Gail and Oil India. The larger share of losses is made good by the government.
Petroleum planning and analysis cell (PPAC) under the petroleum ministry calculates the industry’s under-recoveries. 
During the June ’12 quarter, the three oil marketers together had posted an unprecedented net loss of . 40,536 crore as the dues from government did not arrive. A similar situation is expected to repeat for the September quarter with the OMCs not getting compensation from government so far.
    “We have not received even a single rupee from the government for entire April to September period—neither the money, nor the letter specifying the amount they will pay,” a highranking official in an OMC said.
An official from another OMC said, “With the budgetary provisions for petroleum subsidies over, the government must get parliamentary approval in the winter session to pay oil companies.” 

Q2 Nos Better, but No Signs of Recovery Ye

    India Inc’s results for the September quarter so far have been refreshingly better than in the past couple of quarters, a fact reflected in the stock market with benchmark indices gaining 9% in the past two months, but experts caution a real turnaround is yet to come, reportsRamkrishna Kashelkar from Mumbai. Interest cost, which was growing at 25-50% yearon-year for the past six quarters, rose just 7% in the September quarter.

‘Don’t See a Turnaround in Sept Quarter Bounce’

Operating profit margin of cos improves 16.3%, but experts say macro-economic trends don’t signal a positive trend

    India Inc’s results for the September 2012 quarter have so far been refreshingly better than the stagnating past couple of quarters, a fact that’s reflected in the stock market with benchmark indices gaining 9% in the past two months. And, experts believe that the real turnaround is yet to come.
An ET analysis of 861 listed companies that have published results for the September 2012 quarter, excluding banking and finance companies, reveals that the aggregate operating profit margin has improved to 16.3%, which was the best since September 2011 quarter.
The interest cost of the industry, which was growing at 25% to 50% year-on-year for the past six quarters, rose just 7% in the September 2012 quarter. What’s even more heartening is that for the first time in the past three years, interest cost declined on a sequential basis — the interest burden of all companies put together was at . 10,158 crore, 13% lower from the June 2012 quarter. This resulted in a 29.8% growth in the aggregate net profit to . 48,444 crore, which appears significantly better when juxtaposed against the anaemic growth numbers of the past four quarters.
However, experts are not entirely convinced by these numbers, at least not yet. “Macro economic numbers are not yet signaling a positive trend. We see cost cutting, project delays and postponements in fund raising by corporates on a large scale. We need to wait for another 1-2 quarters before knowing for sure if a turnaround is under way,” said Nilesh Karani, head of research with Magnum Equity Broking.
Sandeep Randery, head of research with BRICS Securities, shares the same view. “It would be premature to call it a turnaround at this juncture. An improvement in the incoming data like auto sales, bank credit growth, etc., would be needed to argue that a turnaround is under way.” If it’s not a turnaround and if the macro-economic indicators are still indicating a slowdown, then what has driven India Inc’s performance this quarter?
The answer apparently lies in appreciation of the rupee through the September quarter. Unlike preceding quarters when the rapidly depreciating rupee would result in forex losses, the currency’s appreciation this quarter has helped companies reduce their other expenses, which is reflecting in improved operating margins.
On the other hand, the data shows that key operating costs like raw material, staff cost, power etc., have not contributed to the improvement in the operating profit margin. In fact, staff cost, at 9.1% of net sales, was the highest in the past three years. Another worrying trend is that the year-on-year growth in net sales at 12.7% has dipped to a level not seen in the past two years. This analysis supports the experts’ opinion that a sustainable turnaround is yet to come. One may argue that even if the rupee goes back to 51-52 levels, India Inc would still be able to turn in another robust performance in spite of its problems. However, for the rupee to sustain at a higher level, the macro-economic indicators will have to improve first. So, investors shouldn’t read too much into India Inc’s performance for the September quarter.

Write-offs, Volume Fall Hit Margin; GAIL Pins Hopes on New Terminals

Public sector GAIL’s results for the quarter to September are a reflection of the woes faced by the domestic natural gas transmission industry.
First, the dwindling availability of natural gas lowered the company’s transmission volumes, and, secondly, the changes in tariff regulations forced it to de-recognise a part of its revenue. Besides, being a state-run company, its subsidy sharing continued to add burden to its profitability. Although the company continues to invest in expanding its pipeline network, an improvement in availability of natural gas and stability in the tariff regime will be key to better financials as well as performance on the bourses.
GAIL’s transmission volumes dropped nearly 11% to 105.6 million units per day from 118.6 million units in the last September quarter. This was also 3.8% lower compared to the preceding June quarter. Still, revenues from the natural gas transmission business were at par with the yearago period, while profits improved 8.7% to . 604.9 crore owing to better margins.
The natural gas trading business was also hit as volumes dropped 3.5% to 80.7 million units daily. With a drop in profit margins, the segment’s profits fell 14.6% against a year ago. The LPG transmission business took a major hit when the regulator, Petroleum and Natural Gas Regulatory Board (PNGRB), revised tariffs relating to the company’s LPG pipeline, which forced it to write off . 123 crore of revenues. As a result, the segment posted a loss of . 48.9 crore, while it had posted a profit of . 72.2 crore a year ago. The company also wrote off a provisional . 785.7 crore towards LPG subsidy, which was 38.6% higher against a year ago. GAIL’s petrochemical business also underperformed with a flattish performance at the profitability level. As for the positives, the company’s other income more than doubled to . 236.8 crore thanks to a 43% jump in its cash balance to . 1,335 crore. However, this is likely to be temporary as GAIL is in the midst of a heavy investment phase and its cash balances will soon get utilised. Its borrowings at the end of September too rose 35.8% from a year ago and the interest cost on these funds will start reflecting once the projects get commissioned. It will take the commissioning of Petronet LNG’s Kochi terminal and the revival of GAIL’s Dabhol terminal to address the industry’s woes relating to falling natural gas availability. On the other hand, PNGRB and city gas firm Indraprastha Gas are locked in a legal tussle in the Supreme Court over tariffs. This means the sector’s problems will continue for a while.

Investors Pin Hopes on Cairn’s Maiden Dividend

Cairn India’s numbers for the quarter to September were in line with market expectations. Investors will now focus on the maiden dividend the exploration firm will announce on October 31.
The company’s ability to secure government approvals to raise production will be the key for it to improve its market value over the next few years.
The company, in its dividend policy announced earlier this year, had indicated a minimum 20% payout ratio — which would mean at least 20% of book profits to be distributed as dividend every year. If the profits of FY12 are taken into account, the dividend would work out to Rs 8 per share, which, according to some experts, will be the minimum the company will announce. However, if the company decides to reward shareholders more generously, it can dig into its cash pile of Rs 12,443 crore — or Rs 65 per share on its books. No wonder, shareholders are eagerly awaiting the announcement on the pay-out ratio.
Cairn’s production for the September quarter at 1,29,431 barrels of oil equivalent daily was 2% higher than in June quarter, but average realisations were down 2.6% to $96.7 per barrel. This resulted in a flat turnover at Rs 4,443 crore quarter on quarter. But, year on year, the turnover was up 67% thanks to growing production. The company had written off one-time expenditure of Rs 1,355 crore on the prior period royalty and cess in the September quarter in 2011. That is why its net profit for this quarter was expected to be significantly higher on y-o-y basis.
The profit figure should have been in line with the June quarter but for the forex loss of Rs 786 crore. Cairn India’s future growth will hinge on how swiftly it can ramp up its production further from its Rajasthan asset, for which timely government approvals will be critical. The company’s pilot project of Enhanced Oil Recovery, or EOR, through polymer flooding is progressing well and it has submitted a field development plan, or FDP, for a full field application of this technique.
The company also plans to invest $2 billion in two years in the Rajasthan field subject to government approvals, and it envisages a possible peak production rate of 3,00,000 barrels daily.

PSU Stocks as Wealth Creators

India’s second largest oil marketing company BPCL has been reeling under the pressure of under-recoveries just like its peers Indian Oil and HPCL. But the company has had success in its petroleum exploration ventures. The most prolific discovery was made in a block offshore of Mozambique where huge natural gas deposits were discovered. BPCL’s 10% stake in the block would entitle it to between 3 and 6 trillion cubic feet of gas at current estimates, which is today worth over $2 billion or more than 40% of BPCL’s current market capitalization. Similarly, the company’s consortiums have made multiple hydrocarbon discoveries in offshore Brazil, Indonesia and Australia as well as in the Cauvery basin. However, these discoveries are in preliminary phases and are being evaluated, which means they are still 4-5 years away from production. Nevertheless, their magnitude is huge when compared to BPCL’s size today. By 2017-18 when the revenues from these assets start flowing, they could contribute the biggest chunk in the company’s total profits. The company’s dependency on government for its profitability would then recede substantially.

Other Income, Refining Power RIL’s Return to Billion-$ Club

But worries remain as petrochem segment hits a new low and oil & gas continues to decline

    Reliance Industries (RIL) once again posted a net profit of over $1 billion in a single quarter (July-September 2012) after a gap of three consecutive quarters. However, this is unlikely to impress investors as its petrochemical business dropped to a new low, while a large chunk of its profits came from other income.
If the global economic weakness results in a slump in refining margins as well, the company could find it difficult to repeat its performance in the next couple of quarters.
“Maintaining similar profitability in coming quarters appears challenging for Reliance Industries given the macro-economic trends that would put pressure on refining margins as well as on petrochemical segments,” said Sandeep Randery, head of research with BRICS Securities. A Morgan Stanley report on Reliance Industries last week cited expectations of a weaker margin environment in refining and a subdued outlook on petrochemicals as key factors before turning cautious on the company and downgrading it from ‘Equal-weight’ to ‘Underweight’.
Petroleum refining was the sole driver of profitability in this quarter. The segment reported gross refining margin (GRM) — the differential between the cost of a barrel of crude oil and realisation from sale of refined products produced from it — at $9.5 per barrel.
This was the best number in the last four quarters. But, it was lower compared with $10.1 it had reported in the September quarter of 2011. This coupled with high operating rates boosted profits from this segment to the highest ever. 
On the other hand, the petrochemicals segment that has been under a lot of pressure for a prolonged time witnessed its profit margins dip to the historically lowest level of 7.9%.
The segment’s profit at . 1,740 crore was the lowest in the last three years. The sector’s woes, however, are unlikely to get over in a while.
The third key segment of oil and gas production continued to drift lower with dwindling gas production from the KG basin. Its profits for the September 2012 quarter, too, were the lowest in three years. Unless the company goes ahead with a further capex in this field, profits are expected to continue declining.
In this scenario, the company’s growing cash balances have come to its rescue, as other income contributed 31% of its pre-tax profits. This maybe a good thing for maintaining profits at decent levels and reflects the debt-free, cash-rich balance sheet. 
    But the same cash reserve is a drag when it comes to company’s capital efficiency.
The above mentioned Morgan Stanley report had also pointed out the ‘increased risk of investments into the low-RoE businesses,’ as one of the reasons behind downgrading it.
It is, therefore, more likely that the street would treat RIL’s results as a nonevent. The scrip will continue to take cues from developments in the global economics and Indian regulatory environment — issues like KG basin capex and natural gas price revisions post 2014.

Other Income, Refining Power RIL’s Return to Billion-$ Club

But worries remain as petrochem segment hits a new low and oil & gas continues to decline

    Reliance Industries (RIL) once again posted a net profit of over $1 billion in a single quarter (July-September 2012) after a gap of three consecutive quarters. However, this is unlikely to impress investors as its petrochemical business dropped to a new low, while a large chunk of its profits came from other income.
If the global economic weakness results in a slump in refining margins as well, the company could find it difficult to repeat its performance in the next couple of quarters.
“Maintaining similar profitability in coming quarters appears challenging for Reliance Industries given the macro-economic trends that would put pressure on refining margins as well as on petrochemical segments,” said Sandeep Randery, head of research with BRICS Securities. A Morgan Stanley report on Reliance Industries last week cited expectations of a weaker margin environment in refining and a subdued outlook on petrochemicals as key factors before turning cautious on the company and downgrading it from ‘Equal-weight’ to ‘Underweight’.
Petroleum refining was the sole driver of profitability in this quarter. The segment reported gross refining margin (GRM) — the differential between the cost of a barrel of crude oil and realisation from sale of refined products produced from it — at $9.5 per barrel.
This was the best number in the last four quarters. But, it was lower compared with $10.1 it had reported in the September quarter of 2011. This coupled with high operating rates boosted profits from this segment to the highest ever. 
On the other hand, the petrochemicals segment that has been under a lot of pressure for a prolonged time witnessed its profit margins dip to the historically lowest level of 7.9%.
The segment’s profit at . 1,740 crore was the lowest in the last three years. The sector’s woes, however, are unlikely to get over in a while.
The third key segment of oil and gas production continued to drift lower with dwindling gas production from the KG basin. Its profits for the September 2012 quarter, too, were the lowest in three years. Unless the company goes ahead with a further capex in this field, profits are expected to continue declining.
In this scenario, the company’s growing cash balances have come to its rescue, as other income contributed 31% of its pre-tax profits. This maybe a good thing for maintaining profits at decent levels and reflects the debt-free, cash-rich balance sheet. 
    But the same cash reserve is a drag when it comes to company’s capital efficiency.
The above mentioned Morgan Stanley report had also pointed out the ‘increased risk of investments into the low-RoE businesses,’ as one of the reasons behind downgrading it.
It is, therefore, more likely that the street would treat RIL’s results as a nonevent. The scrip will continue to take cues from developments in the global economics and Indian regulatory environment — issues like KG basin capex and natural gas price revisions post 2014.

Other Income, Refining Biz may Boost RIL’s Net

Petrochem, E&P segments could weigh heavy in the Sept quarter, feel analysts

    As Reliance Industries (RIL) readies to publish its results for the July-September 2012 quarter on Monday, analysts expect the company’s performance to be better sequentially, but lower compared to the year-ago level. The refining segment and other income are likely to boost profitability, but the petrochemicals and E&P segments are likely to weigh heavy on the company’s performance in the September quarter. The aggregate net profit of the energy behemoth is estimated between . 5,317 crore and . 5,550 crore for the September quarter, which will be significantly better than the . 4,473-crore profit posted in the June 2012 quarter. However, compared to the net profit of . 5,703 crore in the September 2011 quarter, RIL is likely to see a 2.5% to 7% fall. 
Gross refining margins (GRM) — the difference between the cost of a barrel of crude oil and the price at which the processed output can be sold — have improved during the September 2012 quarter from previous three quarters. According to a DSP Merrill Lynch report, the September 2012 quarter Reuters’ Singapore complex GRM at $9.13 per barrel was flat against the year-agoperiod, but up 37% from $6.65 of the June 2012 quarter. RIL, which is known to report GRM marginally above the Reuter’s Singapore benchmark, should post between $9 and $9.5, according to majority of brokerage analysts. This will be lower compared to the $10.1 it posted in September 2011 quarter, but higher than the $7.6 of June 2012 quarter.
The company’s KG basin output is expected to average 29 mmscmd during the quarter from 32.1 mmscmd in the previous quarter. Similarly, the petrochemical segment’s profitability is likely to remain under pressure. “Average prices of petrochemical products remained flat on a sequential basis during September 2012 quarter in rupee terms, as an increase in crude oil prices was offset by lower demand for petrochemicals,” noted Angel Broking’s preview report. This is expected to result in a weaker operating profit for the quarter compared to the corresponding period of the previous year. However, a spurt in other income, thanks to growing cash reserves of the company, will limit the fall in profit. Bank of America Merrill Lynch expects an 81% jump in other income, which was . 1,102 crore in the year-ago period. Similarly, it expects a fall in effective rate of tax to 18% of pre-tax profits from 22% in the year-ago period to further cushion the fall in net profit.

Lower Margins, Payment Delays may Bog Down Sintex

After four consecutive quarters of yo-y profit fall, the 86.7% jump in Sintex Industries’ September quarter net profit was something that might have rekindled hopes of a turnaround for the company’s investors. This was reflected in the 5.7% jump in its share price with strong spurt in volumes post results. However, the scenario is not so clear. The company’s challenges persist and it still appears a few quarters away from a real turnaround.
The main reason behind Sintex’s profit jump was a 92% reduction in its forex losses to . 4.9 crore that boosted its pre-tax profits by . 55 crore compared with the year-ago period. Excluding this, the pre-tax profits at . 102.7 crore were down 18%. This was a reflection of the persisting weakness in the company’s operating performance, particularly with the September 2012 quarter operating profit margins weakening to 11% from 13.8% in the year-ago period.
The monolithic construction business, which till last year was the single largest segment, has been facing delays in payments from state governments. This has resulted in a long debtor recovery cycle and a stretched balance sheet. The September ’12 quarter results didn’t offer any positive cue in this regard as well. “The company’s working capital cycle, currently at 47% of annualised sales, has neither improved nor worsened from the last quarter. So, the company is just stabilising and no improvement is in sight just yet,” noted Jignesh Kamani, research analyst with brokerage firm Nirmal Bang.
Even the company acknowledges that the things are yet to turn around. The comments by Amit Patel, managing director of the company, accompanying the results press release, mentioned a time frame of “next couple of years” to achieve key financial targets and for bouncing back.
These key financial targets include improving return ratios, ensuring better working capital management and shrinking the overall size of the balance sheet. 

PETROLEUM SECTOR: Strong Re, Better Refining Margins to Prop Up Cos in Q2

Indian petroleum industry’s performance in the September 2012 quarter is likely to be better than in the June 2012 quarter, thanks to a stronger rupee, higher refinery margins and reduced under-recoveries.
However, compared with the year-ago period, the results would appear subdued. Again, the profitability of petroleum PSUs remains dependent on the government’s subsidy-sharing plan.
Crude oil prices, which had dropped to below $90 a barrel in the second half of June 2012, gained steadily to cross $115 by mid-September — the prices marginally eased later. The Indian basket of crude oil averaged $107 per barrel in the September quarter, which was on a par with the preceding quarter.
Nevertheless, the daily under-recovery figures given by the Petroleum Planning & Analysis Cell (PPAC) show that the industry’s daily under-recovery fell to . 430 crore in the September quarter from . 510 crore in the June quarter. This hints at a reduced under-recovery burden for the quarter.
The rupee dropped to a fivemonth low of 52.7 against the dollar at the end of September. Apart from reducing India’s crude import cost, it will enable companies, which were booking forex losses in the June quarter, to book forex profits now. Stateowned oil marketing companies will particularly benefit from this.
Gross refining margins (GRM) were steadily growing through the September 2012 quarter. A recent report by Bank of America Merrill Lynch acknowledged that in the September quarter, the benchmark Singapore refining margins, on average, had reached their highest level in four quarters. This will help standalone refiners, including MRPL, Essar Oil and particularly Reliance Industries. The benchmark refining margins are still lower than the year-ago levels.
“We expect RIL’s GRMs to be up 15% Q-o-Q, but down 10% Y-o-Y at $9 per barrel. The average gas production from KG-D6 will decline 8% Q-o-Q and 34% Y-o-Y to 30 mmscmd and other income will rise 50% Y-o-Y to . 1,650 crore. We estimate its net profit to increase 19% Q-o-Q, but decline 6.5% Y-o-Y to . 5,320 crore,” says a BRICS Securities note.
Most petroleum companies are expected to follow this trend and post better results in the September quarter, compared with the June quarter, but weak compared with the year-ago quarter.
However, Cairn India could be a major exception. The company had booked onetime expenses of over . 2,500 crore in the September 2011 quarter. Further, the company’s production has improved 33% to 1,31,000 barrels per day from the year-ago levels.
When it comes to the performance of the three oil marketing companies, everything would depend on the government’s ability and willingness to compensate them for the under-recoveries.
The trio had reported record losses in the June 2012 quarter when there was no compensation from the government. 
KEY POINTS The rupee dropped to a five-month low of 52.7 against the dollar at the end of September. This will reduce oil import cost
Daily under-recoveries of the industry have fallen to . 430 crore in the September quarter from . 510 crore in the June quarter
Gross refining margins were steadily growing through the September 2012 quarter. This will help oil refiners

15 L Investments in These Cos would’ve Earned 45 L in 5 Yrs

Dr Reddy’s, Cairn among 15 that have improved return on capital employed

Drug maker Dr Reddy’s Labs, truck-financing company, Sriram Transport Finance, oil exploration firm Cairn India and Mcleod Russel feature in a list of 15 companies which have steadily improved their return on capital employed, or RoCE, between FY08 and FY12. RoCE is a measure of how gainfully a company is able to deploy or use its capital. A company which can generate higher profits from a lower capital base will always be better off compared to firm which needs higher capital to generate the same level of profit. In other words, a company with higher RoCE will be preferred over a company with a lower RoCE. This is reflected in the fact that companies with high RoCEs like most leading FMCG companies command premium valuations.
An analysis by the ET Intelligence Group of BSE 500 companies shows that between FY08 and FY12 there were 15 companies which improved their RoCEs, out of which 12 — Bata India, Supreme Industries, Dr Reddy's Labs, Kajaria Ceramics, Shriram Transport Finance, Lupin, Bajaj Finance, Page Industries, M & M Financial, Mcleod Russel, Solar Inds and Cairn India — have emerged as multi-baggers.
Even at the peak of market valuations at the end of 2007, if an investor had bought into each of these stocks by putting in . 100,000, the total investment of . 15 lakh would be worth . 45 lakh today despite the BSE Sensex trading at over 10% below its peak.
It is but natural that leading investment managers often rely on this ratio when taking their investment decisions.
Says Sunil Jain, head of equity research (Retail) at Nirmal Bang Securities, “RoCE is also used for comparing within the peer group while selecting a company for investment. We have seen that the expansion of RoCE generally leads to the expansion of price-to-earnings ratio (P/E). Thus, an investor benefits on two counts. One is through increase in earnings and second is by expansion of P/E. Generally, we avoid recommending stocks with a declining RoCE.”
Says G Chokkalingam, executive director and chief investment manager, Centrum Wealth, “RoCE is a great tool when looking for a defensive investment strategy. “Higher or rising RoCE over the years indicates consistency in growth of both business and profits.”
Although an important tool, RoCE may not always be a pointer to future winners. “This tool has certain limitations – it doesn’t capture possible opportunities arising from turnaround cases, acquisitions or from thematic plays which emerge once in a while in the equity markets,” he said.
Similarly, the market returns of a company also hinge on other variables such as valuation, market sentiment, balance- sheet structure and most importantly future outlook. A rising RoCE indicates robustness of the business – it indicates either rising profitability or a reduction in capital employed. The capital employed can be cut either by reducing the working capital or by paying out excess cashthrough higher dividends.
“Rising RoCE gives glimpse of the performance like growth, management qualities, management’s vision, perception, etc in industry and returns for shareholders in terms of good dividend payouts, safe investment ideas,” says Nilesh Karani, head of research at Magnum Stock Broking.

PETRO REFINING: Falling Margins Dim Growth Prospects

Although crude oil prices soared over 25% in the threemonth period July-September 2012, petroleum refiners have not been impacted adversely. In fact, tight supply of products helped refinery margins to stay high, boosting the valuations of Indian standalone refiners. But a prolonged weakness in refining margins could prove to be a drag on their valuations. A recent report on the industry by financial services firm IDBI Capital says that the Singapore complex gross refining margins, or GRMs, rose 22% month-onmonth in August 2012 to $9.9 per barrel, led by a rise in gasoline, gasoil and Jet-Kero crack spread driven by shutdowns of few key refineries. The strong margins were driven by refinery shutdowns in the US and Venezuela, the report said.
There were production shutdowns in the US Gulf of Mexico in the wake of hurricane Isaac, which took nearly 1 million barrels per day refining capacity off stream. Venezuela’s largest refinery, which suffered a blast and the fire killed nearly 40 people in August, had to be shut down. These incidents pushed the prices of refined products higher benefiting refiners globally.
There are already concerns that the boost to refinery margins would be shortlived. According to a JP Morgan report, refinery margins have demonstrated extraordinary strength recently, underpinned by the combined resilience of gasoline and middle distillate cracks. This appears at odds with the tepid oil demand growth and the precarious state of the global economy, raising the question as to whether the strength is sustainable, the report says.
A prolonged weakness is likely as new refineries get added over the next few years, while those expected to undergo a permanent closure resume operations after ownership changes.
An industry update put out by SBI Caps says that its analysis of major refinery projects expected to come onstream shows that after delays of several years, the majority of large projects are on track to be commissioned in the next two to three years. During 2011, around 1.4-mbpd refining capacity was added, taking the total refining capacity to near 93 mbpd compared to an incremental demand of 0.8 mbpd. In 2012, around 1.6 mbpd refining capacity is likely to come on-stream, compared to the expected demand growth of 0.8 mbpd, according to the report.
Shares of Indian standalone refiners — RIL, MRPL and Chennai Petro — gained around 6-16% during July-August, but analysts are not very positive on their outlook. For instance, a recent report by Kotak Securities said that it expected refining margins to soften further once several Asian refineries restart operations These companies may once again underperform the markets if refining margins continue to weaken further.

CRUDE OIL PRICES: Sentiment, not Biz Factors, to Fuel Prices

The global crude oil industry is now witnessing the emergence of two paradoxical trends. At a time when the global demand outlook for 2012 and 2013 is being revised downwards month after month, oil prices are on a boil. Surely, factors other than demand-supply dynamics are having a major influence on oil prices.
The benchmark Brent crude prices rose over 29% since end-June 2012 to $116 in the first week of September. However, the International Energy Agency (IEA), which represents the OECD nations, or mainly petroleum consumers, has revised downward its total demand forecast for 2012 and 2013.
In its latest monthly report IEA noted that global oil demand would average 89.6 million barrels per day (mbpd) in 2012, which is down from 89.9 mbpd estimated in June and 90 mbpd estimated at the start of the year. Sluggish global economic growth is the main reason for this, with persistently high prices taking its toll as well.
GDP growth estimates for the world’s biggest economies are being revised downward. According to the IEA report, “China endures the majority of the reduction”, with its GDP growth for 2012 pegged at 8% (8.2% earlier) and for 2013 at 8.1% (8.5%). The economic outlook for the US in 2013 has been lowered to 2% now from 2.3% last month.
The reasons behind the spurt in oil prices were mainly non-economic. The re-emergence of geopolitical tensions, production problems in the North Sea and hopes that the world’s major economies would act to ease monetary policy were among the main reasons for the overall increase in global crude oil prices, the Organisation of Petroleum Exporting Countries said in August.
Owing to US and EU sanctions, crude oil exports from Iran have fallen nearly 20% since the beginning of the year to 2.9 mbpd now. Oil prices were also boosted by Fed chairman Ben Bernanke’s hint at a third round of liquidity infusion and Hurricane Isaac, which hit the US coast last week.
However, for crude, the demand growth outlook for 2013 is not bullish. IEA expects oil consumption to grow 0.9 mbpd in 2012 and 0.8 mbpd in 2013.
However, at the same time production growth is expected to be healthy. IEA estimates OPEC’s production at 31.4 mbpd for July 2012, while the ‘call on OPEC’ – the volume OPEC needs to produce to balance the global demand and supply – “will recede to 30.4 mbpd for Q4, 12 and to 30.1 mbpd in 2013”.
However, oil prices are expected to be driven by sentiment and liquidity for a while before economic factors prevail. 

Diesel Subsidies Benefit the Haves More than Have-nots

Continuation of subsidies likely to put oil cos in a financial crisis and increase the burden on the govt

    Soaring diesel consumption by fleet owners, telecom companies to keep their towers running and malls to pamper their affluent customers is blowing up the theory that continuation of diesel subsidies is intended to help farmers and truckers in order to keep inflation low.
Diesel consumption is growing at a rapid pace that is lining the pockets of the business community rather than the government’s intention to help poor farmers and truck owners which are mostly individual businesses rather than companies.
The continued subsidy could lead IOC and HPCL to a financial crisis that will raise the burden on the government in future to save them from going bankrupt like its bailout for Air India.
“A good portion of the diesel subsidy is used by sectors where it is not intended to be spent,” said Debasish Mishra, senior director, Deloitte India. “Nearly . 8,000-crore subsidy is consumed by power generating sets in malls and big buildings while around . 3,000 crore of subsidy is spent in powering telecom towers.”
Nearly 16% of diesel is consumed by passenger vehicles, 4.6% by gensets and 2% by mobile towers, translating into a likely subsidy of . 23,000 crore for this fiscal, a calculation by ETIG shows. In the April-July 2012 period, India’s diesel consumption grew 10.9%, although the total petroleum consumption was up just 6.2% underlining the overall trend of economy’s dieselisation. The Indian petroleum industry is set to suffer under-recoveries exceeding . 1-lakh crore on diesel alone for FY13.
Continuation of diesel subsidies has become sensitive for investors and the political class as it is creating a crater in the government’s finances where fuel subsidies are set to touch a record high this year.
Subsidies, intended to keep the cost of operations low for farmers and truckers, are being enjoyed by the rich who drive around utility vehicles produced by Mahindra & Mahindra and Toyota Kirlostar, the top-selling models. There have been many recommendations, including one by the Kirit Parikh Committee, to free up fuel prices.
“The increase in under-recoveries can also be attributed to increased consumption of regulated fuels like diesel by private car owners due to a significant difference in prices compared to other alternate fuels like petrol,” says Rahul Prithiani of ratings firm Crisil.. “The difference between the running cost for a petrol car vis-à-vis a diesel car has gone up by nearly 85% in the past 7-8 years. Therefore, diesel cars have become more lucrative for buyers.”
The proportion of diesel cars in total car sales has increased to 38% in 2012, from 20% in 2006, which has pushed up the share of diesel in the overall petroleum product consumption to 44%, from 36%. Policymakers have been debating about many ways to continue with subsidies and eliminating the undeserving from benefiting because of the scheme. “In India, nearly 80% of diesel sales happen through retail outlets,” says a director at Petroleum Planning and Analysis Cell under the petroleum ministry, who did not want to be identified. “There has been no tracking mechanism to check the final usage of diesel sold through petrol pumps. The estimates we have are based on dealer feedback. Still, there is no doubt that the diesel consumption is growing in areas where subsidies are not justified. We plan to conduct a scientific study over the next one year to establish the consumption pattern with more clarity.”
But the damage to the country’s fiscal position and oil companies’ finances may well be done before a mechanism is evolved.
The under-recovery on diesel — the shortfall between the domestic price and what it would have cost to import — contributed to merely 44% of the industry’s overall under-recovery in fiscal 2011, but rose to 58% in the following year. In the first half of this year, it was at 60.7%. Oil companies are losing . 13.76 per litre on diesel.
If things continue at the same rate, the under-recoveries on diesel alone will cross . 1-lakh crore for FY13, provided the year’s consumption volumes stay restricted to the projected figure of 68.5 million tonne. If the diesel consumption maintains at the 10.9% growth rate seen in the April-July 2012 period till the year end, this figure may cross . 115,000 crore, according to ETIG estimates.
If the subsidies are not ended, it is trouble for the government.
“The government will be left with no option but to borrow additional funds to compensate OMCs during the year, thereby adversely impacting the government’s fiscal position, assuming other factors remain constant,” says Crisil. “This, in turn, could exert further upward pressure on interest rates and will also limit the government’s ability to fund critical social and infrastructure projects.”

High Debt, Refinance Cost Add to Aban Stress

Even after five years of its highly leveraged buyout of Sinvest, debt-laden Aban Offshore is not fully out of 
the woods yet as its operating cash flows fall short of its debt repayments. The company actually ended FY12 with higher debt compared to the year-ago period, according to its consolidated balance sheet. In the background of a tepid June ’12 quarter, some action towards deleveraging or higher charter rates for its rigs will boost the scrip.
While Aban Offshore has brought down its debt-equity ratio from 20.4 at FY07 end, it still remains high at 4.1 at March ’12 end. The company has been paying more than half of its EBITDA towards interest on loans ever since. Heavy interest outgo means the company has less cash left to repay its debts. This means it needs to refinance its maturing debt by raising more debt. Aban’s consolidated debt grew 16% y-o-y to . 11,701 crore.
Higher cost of refinancing has also taken its toll on Aban’s financial performance as its interest charge at . 312 crore increased 42.8% yo-y. Emkay’s report on the quarterly results mentioned higher coupon rate for Aban’s refinanced bond issues — first bond issued at a coupon rate of 12% and the second bond redemption at a coupon of 14.25% vs earlier 9.3% — as a key reason. The net profit for the quarter was down 41.1% to . 52.1 crore.
The company is hoping for external commercial borrowings to refinance its domestic loans at substantially lower rates. Similarly, it has enabled its board to raise up to $400 million by issuing equity or quasi-equity instruments. However, considering the current market conditions, this is unlikely to mean much.
Now, a lot will depend on the company’s ability to secure long-term deals for rigs, improve utilisation rates and ensuring higher rates. Its FY12 show remained subdued as three of its vessels remained off-stream for an upgrade.
The company appears optimistic about its future. “We expect to have all our rigs deployed through FY13 (except FPU Tahara) at relatively attractive rates across fairly long tenures, which should translate into revenue and profit predictability,” said its MD Reji Abraham in the annual report. 

Specialty Chem Stocks Rise up to 60% in a Yr

    India’s specialty chemicals companies have generated returns ranging from 10% to 60% over the last one year, when the BSE Mid-cap and Small-cap indices have given negative returns and the benchmark Sensex generated barely 3% returns.
The specialty chemicals segment benefits from the fact that unlike commodity chemicals, they are not exposed to profit volatility.
Not all companies can be equally agile in launching new products, but unveiling a specialised product in which the scale of operations can be built is good enough to help them remain ahead of the pack.
For instance, Mumbai-based Vinati Organics has emerged as the world’s biggest manufacturer of IBB — a specialty chemical used in the manufacture of anti-inflammatory drug ibuprofen — and the second biggest manufacturer of ATBS — a monomer used in the petroleum industry to secure crude oil out of deep wells. Similarly, Camlin Fine Sciences has emerged as a major player in food anti-oxidants, a segment in which it wants to grow capacities further.
The benefits of specialty chemicals are also luring traditional bulk chemical makers. Gujarat-based Atul Limited, a colorants and agrochemicals company, recently commissioned the world’s biggest plant to manufacture p-Cresol — a specialty chemical used in the fragrance and personal care industry.
Down South, Thirumalai Chemicals, a traditional supplier of phthalic anhydride to the paint industry with a plant near Chennai, has ventured into this segment by making food acids. It is now one of the world’s top four producers of malic acid with a capacity of over 6,000 tonnes. “Malic acid is naturally found in apple and is better than citric or tartaric acid as a food additive. We are now the only producer in
    Asia,” says R Parthasarathy, MD, Thirumalai Chemicals. The specialty chemicals business is driven by specialised assets and knowledgebased applications that make it more complex and provide higher and more stable margins, says Rajendra Gogri, vice-chairman and MD of Aarti Industries.
“Thanks to our robust research and development, we come out with three to four new molecules every quarter. Often our products are new to the Indian market. Our strategy is to avoid such products which even others can make,” says Pravin Herlekar, CMD, Omkar Specialty Chemicals. The investment scenario may be bleak, but that has not taken the sheen off the specialty chemical industry. FDI into this sector was among the highest in 2011-12, says Kumar Kandaswamy, senior director, Deloitte Touche Tohmatsu India, according to whose estimates $7 billion of foreign flows have come in already.
Even local firms are investing heavily. Omkar Specialty has outlined .100 crore of investments over the next two years, more than tripling its gross block. Similarly, Atul is planning to expand p-Cresol capacity within months of commissioning it. Tata Strategic Management Group’s chemical and energy practice head Manish Panchal says, “Substantially lower penetration, increasing globalisation and higher disposable income are fuelling growth of end-user industries. This industry is expected to grow at 13-17% over the next five years.” Deloitte’s Kandaswamy also projects a 14% growth over the next five years for the sector. The industry is also benefiting from macro-economic trends. “In the last few months, depreciation of the rupee, appreciation of the yuan and increase in production cost in China have helped Indian companies to garner more market share. These firms are likely to continue outperforming in the next one year,” Sunil Jain, head of equity research – retail, Nirmal Bang Securities, said. 

Worst may be over for Essar Oil, but Debt a Worry

Refining company Essar Oil’s profit numbers for the quarter to June was one of the worst in its history. But the worst appears over for the company. That is because of the capacity expansion which has been completed and significantly improves its ability to earn higher margins, a signal perhaps that this could well be the last loss-making quarter for the company. Its huge debt pile remains a major hurdle now, but recent events indicate some improvement on that front. So far, the company had a history of mostly losses and mounting debt as long delays in project execution led to it missing the bull run in the refining industry, cost escalations and the recent trouble with Gujarat over the state’s refusal to extend sales tax benefit hit it hard. However, it has successfully completed its planned capital expenditure taking its refinery capacity to 20 million tonne annually and a complexity level to match that of the local big daddy — Reliance.
The refinery’s improved complexity — a trade terminology which measures the ability to convert worse types of crude oils to make better grades of fuels — will prove a key to better margins and help it remain profitable even during the down cycle. It is confident of earning $7-8 on each barrel extra over the benchmark Singapore refinery margins calculated by the International Energy Agency.
The losses it incurred during the Jun ’12 quarter were due to the stabilisation period that its newly commissioned units needed. And the company has not wasted any time in making full use of its facilities. Essar Oil's MD and CEO, LK Gupta said that the company was now operating the refinery at 20 MTPA, which is its rated capacity. “The losses through the April-June ’12 quarter were mainly attributable to inventory losses of . 700 crore as global oil prices crashed. The rupee depreciation led to a loss of around . 150-200 crore, while interest and depreciation jumped on projects commissioning,” said CFO Suresh Jain. The company’s recent exit from the CDR mechanism and its ability to arrange $1 billion worth of loans to pay Gujarat as sales tax dues underline the credibility of the company’s future cash generation. The stock, although volatile, has not fallen much in 2012. These facts support the overall positive view on the company’s future. 

ONGC Oil: Find a Big Boost, But Subsidy a Worry

After years of production stagnation, ONGC’s huge new discovery in western offshore is something that can really end its production woes. Since the full benefit of this incremental production will come in FY14 and there are other discoveries set to begin production in FY15 and onwards, the current fiscal could very well be the last year of stagnating production for the oil behemoth.
Along with the June 2012 quarter results, ONGC also announced discovery of an additional reservoir in an already producing D1 field in western offshore. Since the field is already producing, the new discovery can be quickly put to production. The output expected jump will add nearly 1.15 mt to ONGC’s annual production, which is 4.8% of its FY12 production at the standalone level. This will be a very big moment for the company, which has seen its production steadily fall from 26.05 million tonne in FY07 to 23.71 million tonne in FY12 – a decline of nearly 2% annually. Its woes seem to exacerbate in the first quarter of FY13, with the production falling 4.9% to 5.64 million tonne. It was surprising for ONGC to post a resounding 48% jump in profit for the June 2012 quarter. Not just that its production was down, the company also had to bear a bigger burden of subsidies while the average international oil prices were down.
The profit rise was made possible by a heavily-depreciated rupee. ONGC’s net realisation – what it is allowed to retain after giving mandatory discounts to oil marketing companies – was 16% higher at . 2,527 per barrel, although in dollar terms it fell 4.4% to $46.62. For the quarter, the company extended discounts of . 12,346 crore – . 300 crore more than what it gave in the June ’11 quarter. Similarly, its overall expenses were up nearly . 1,200 crore from the year-ago period due to oil cess. With oil prices risng and the outlook positive for ONGC’s production, its future should be considered bright, barring for one thing – its share in petroleum sector under-recoveries. The government’s limited ability to fund these losses and a lack of political will would raise retail fuel prices, a rising proportion of this burden could be transferred to the upstream firms like ONGC. Due to uncertainty over this key matter, market’s reaction to ONGC’s strong results and the new discovery should remain muted. 

KEY POINTS The expected jump in production will add nearly 1.15 mt to ONGC’s annual production
It’s surprising for ONGC to post a resounding 48% jump in profit for the June 2012 quarter

INDIAN OIL: Losses to Take the Sheen Off Navratna Co

The country’s biggest petro-retailer, Indian Oil, posted its largest-ever quarterly loss in the June 2012 quarter on heavy under-recoveries, inventory as well as forex losses. This loss has also wiped out nearly 40% of the company’s net worth at the end of FY12. If things don’t change fast, the Navratna PSU will end up as a sick company with negative net worth is another two quarters.
Indian Oil’s net loss for the June quarter was an unprecedented . 22,451 crore — a six-fold increase from the year-ago level of losses. This erased all the profits it had made over the last three years — . 4,226 crore in FY12, . 7,831 crore in FY11 and . 10,713 crore in FY10.
The company lost over . 17,485 crore by selling diesel, LPG and kerosene at government-regulated prices that are way below the cost, becoming the biggest factor for the company’s huge net loss in the June quarter. The loss could have been higher had it not been for the discounts of . 8,041 crore that the upstream companies like ONGC, Oil India and Gail extended. The fall in crude oil prices towards end June might have helped the company reduce its under-recoveries, but they knocked . 4,062 crore off its inventory value, which was worth $7.54 per barrel. Since this was significantly higher than the company’s gross refining margins (GRM) for the quarter, it posted a negative GRM of $4.81 per barrel. On top of these two mega-losses, the company also took a . 3,187-crore hit on foreign exchange as rupee depreciated over 11% through the quarter.