Thursday, June 28, 2012

GLOBAL COAL PRICES: Glut, Changing Fuel Usage Could Keep Prices Low

Global coal prices are currently trading at nearly 20-30% below their year-ago levels. The benchmark Newcastle thermal coal fell to a two-year low of $87 per tonne in June 2012, which traded at close to $142 per tonne at the beginning of 2011. Similarly, the Indonesian coal reference price too was trading around $96.65 in June ’12 from a peak of $127 in early 2011. Although prices have crashed with no bounce back in sight, a further downside appears limited.
“Major reasons for this decline include China’s economic slowdown and high coal inventory levels, increased production and exports from Indonesia and Australia, and increased exports by US coal producers due to cheap natural gas displacing coal used in US power generation,” according to a Fitch report.
For the power industry, coal is the most critical input. With domestic production falling short of demand, India has been increasingly importing coal, which is estimated to top 130 million tonne in FY13. The slide in the spot coal prices bodes well for power producers. “As a rule of thumb, for every $10 fall in the price of 5,000-kcal grade coal, an Indian power utility’s cost of production falls by . 0.27-0.28 per unit. However, the rupee depreciation is likely to erode this benefit,” said Debasish Mishra, senior director, energy & resources, Deloitte India.
While the global oversupply situation is not likely to improve in the near term, most experts reckon that coal prices may not fall much from here. James O’connell, senior managing editor, International Coal at Platts, says that coal prices appear to have a limited downside from 
here on. “Our understanding is that a further fall in coal prices would gradually make producers cut down production. In fact, in countries like Indonesia, small and medium-sized miners are already scaling back output. Coal prices are already near the marginal cost of production for a few of them,” he says. A Fitch Ratings report also echoes this. It forecasts that high-cost producers in Australia and the US would undertake production cuts if the current low price environment spills over into 2013. Such a move would limit production growth and help address oversupply, it argues. A recent industry overview report on Asia-Pacific coal by Citigroup also says that the coal price correction will prove cyclical. According to it, the only worry is about excess supply. “Prices could stay at the current low levels or move lower as long as the US is adjusting to cheap natural gas,” the report says. However, an upturn in prices could well be round the corner. The Citi report says that their understanding is that around 10-15% of Japanese contract thermal coal demand is on a July-June year-term and that industry sources suggest that fresh deals could be struck at around $105 per tonne, well above the spot prices and prove to be a positive surprise. 

Friday, June 22, 2012

CRUDE OIL: Prices to Remain Low for Now, but may Rise in a Year as Demand Grows


Crude oil prices have been on a secular downtrend for the past couple of months owing to the downside risks facing the global economy and rising hopes of Iran tensions easing. The weakness is likely to persist in the near term. However, there is an emerging consensus that oil prices are bound to go up in a year or so. India, which is staring at the prospect of a sovereign downgrade, risks losing out unless it takes advantage of the low oil prices now.
The Indian basket of crude oil, at $94 per barrel, is now 25% lower than what it was at its peak in March 2012, thanks to growing concerns over Eurozone crisis and a weak global economic outlook and resultant lower demand expectations.
Concerns over Iran’s nuclear ambitions persist even after three rounds of discussions, but the promise to continue the dialogue on July 3 is considered a positive. Since this coincided with ample availability of crude oil in global markets and a lack of monetary booster from the US Federal Reserve in the form of a QE3, prices have eased.
The scenario is not expected to change dramatically in the near term although world oil demand is projected to increase slightly during the second half of 2012. “This rise in demand is expected to be mostly offset by the projected increase in non-OPEC supply,” noted the Organisation of Petroleum Exporting Countries in its recently concluded conference.
OPEC has said that, in addition, comfortable stock levels — which are above the historical norm in terms of days of forward cover — indicate that there has been a contra-seasonal stock build up in the first quarter of 2012. This overhang is expected to continue throughout 2012, it said. OPEC's assessment is that stocks outside the OECD region have also risen. Taking these developments into account, the second half of the year could see a further easing of fundamentals, despite seasonally higher demand, it said.
Yet, there is a growing consensus that it will not be long before crude oil prices move northward again. Although demand growth fore
casts are made against the backdrop of muted economic growth, there could be surprises, says the International Energy Agency (IEA), which represents oil consumers.
A lower GDP sensitivity this month illustrates downside demand risks, but upside potential exists too, amid uncertainty over summer power sector oil demand and non-OECD stockpiling, it says. The energy industry watchdog expects demand to grow 0.82 million barrels per day (mbpd) to an average 89.9 mbpd in 2012.
One of the key reasons of a growth in demand will be increased refinery activity. World refinery crude demand is set to surge seasonally by 2.8 mbpd between April’s low and August, as maintenance at refineries winds down.
US-based investment bank Goldman Sachs too is bullish on crude oil for the next one year. Oil falls under its top commodity picks according to its latest report. Returns may be 41% in a year for energy investments, it says, while adding that the oil market is tightening. A significant change in crude oil prices could be a scary scenario for India, which imports 84% of its requirement and heavily subsidises its domestic retail sales.
Even at current prices, the three state-run oil marketing companies (OMCs) are losing . 446 crore daily. In FY13, under-recoveries could be as high as . 1,66,000 crore if there is a status quo, further strengthening the case for deregulating the retail prices of fuel to take advantage of low crude prices now.



Wednesday, June 20, 2012

Supreme Industries is Riding on Revenue Growth, New Capacity


Mumbai-based Supreme Industries has outperformed the indices even in a choppy market over the past one year. Strong return on investment has made it attractive to a growing number of institutional investors and helped it maintain a premium valuation over its peers.
The company’s expansion plans for the coming months could further boost its sustained growth.
Supreme Industries is India’s leading plastic goods manufacturer, with 19 plants across the country and annual volumes of close to 2,30,000 tonnes. The company has a comprehensive range of offerings, including piping, packaging, industrial and consumer products.
The company has recently developed a commercial complex in Andheri in Mumbai, which currently has 1,90,000 sq ft of unsold inventory. During the July 2011 – March 2012 period, the company had sold 41,678 sq ft of inventory at . 16,600 per sq ft. At this rate, the unsold inventory is valued at . 315 crore.
In the 12-month period ended March 2012, the company’s sales grew 15.7% to . 2,745.7 crore while net profit grew 16% to . 200.7 crore. It was able to improve its operating profit margins by 50 basis points to 15.4% from the previous year.
The company has been focusing on value-added products to ensure that its operating profit margins improve along with sales growth. For the financial year ending June 2012, the company had chalked out a . 250-crore capital expenditure plan. Its protective packaging unit at Hosur in Tamil Nadu will be operational by June end, while the cross-laminated film plant at Halol in Gujarat is expected to commence operations by September 2012.
Supreme’s 400,000 unit-per-annum composite cylinder plant at Halol is scheduled 
to be completed by December 2012. By October 2012, its piping systems plant at Malanpur in Madhya Pradesh will be ready. The company, which processed 2,24,673 tonnes of polymers last year, expects to finish the current financial year with 10% higher volumes. Revenue growth, however, is likely to be higher at 20% thanks to higher raw material prices getting passed on to consumers. The growing share of value-added products in its portfolio too is contributing to its bottom line.
The stock continues to command a premium valuation of 13.5 price-toearnings multiple (P/E), which is higher than the 9 to 11 range in which its peers such as Time Technoplast, Astral Poly Technik and Jain Irrigation trade.
Supreme Industries was 
able to consistently outperform the market due to its strong return on employed capital (RoCE), which stood at close to 35% for the past three years.
The Supreme Industries stock has been witnessing increased institutional participation. Institutional holding in the company has more than doubled to 18.21% at the end of March 2012 from 8.11% a year ago. The promoters have maintained their stake at 49.62%.


LIQUEFIED NATURAL GAS: Improved Supplies could Reduce Prices Further

Notwithstanding the crash in crude oil prices over the past couple of months, spot LNG prices in Asia peaked in May, before cooling off in June. Strong demand from Japan and South Korea is keeping prices high, but easing supplies are leading to a softening of prices now.
“Spot LNG prices are currently softening in Asia,” confirmed Hong Chou Hui, managing editor, Asia LNG, Platts. “Just a month ago, prices of spot LNG cargoes delivered to Japan and South Korea were at a high of $18.50/ mmBtu, while they were $15.75/ mmBtu for west India. They have since come down to $16.825/ mmBtu for Japan and South Korea, and $14/ mmBtu for west India as of June 15, 2012,” he said.
An improvement in supply is considered as the main reason for the fall in prices as the demand for LNG is still healthy. Hong said that the key factor is a global supply overhang, with spot LNG cargoes readily available from Nigeria, Trinidad & Tobago, Australia and Indonesia. It also coincides with the end of planned maintenance programmes at various liquefaction facilities in different
parts of the world.
Japan’s LNG demand rose substantially in the past year as the country continued to reduce nuclear power generation in the wake of the Fukushima disaster.
The demand-supply dynamics warrant spot LNG prices to fall further to more realistic levels in the coming weeks, say $13 per mmBtu, says AK Balyan, managing director and CEO of Petronet LNG, which is India’s biggest LNG importer.
Sameer Bhatia, consulting leader - oil & gas, Deloitte Touche Tohmatsu India, believes any moderation in spot LNG prices would not be significant. According to him, the short- and mid-term outlook is bleak, with spot prices expected to stay high.
In the long run, however, things could be better again, he believes. Demand from Japan will cool off a bit as it has already initiated deliberations on getting select nuclear capacities back on track. And there is hope of China replicating the US shale gas success story, albeit in a smaller way. More supplies from Australia and even the US could cause some moderation in prices as well. 

Monday, June 18, 2012

PETROLEUM INDUSTRY: More Pain Ahead for Petro Cos as Under-recoveries Soar


Indian petroleum industry's woes are likely to worsen in FY13 as the total under-recoveries zoom to a record high of 1,70,000 crore, up 22.7% from 1,38,541 crore in FY12. This is notwithstanding the recent fall in international oil prices, benefits of which have been blunted due to the weakness in the rupee.
India continues to keep retail fuel prices under control disregarding high crude oil prices and even though we import 84% of our crude requirements. Out of the 204.8 million tonne crude oil processed by Indian refiners during FY12, 172.11 million tonne was imported while the domestic production stood at around 38.4 million tonne. This high import dependency means high prices lead to a widening trade deficit for the country. Nevertheless, the government continues to offer these fuels at heavy discount to consumers. For the first fortnight of June 2012, the petroleum ministry estimates pegged losses of 12.53 per litre on diesel, 30.53 per litre on kerosene and 396 per cylinder of LPG. These may be marginally lower to comparable figures from March 2012 when oil prices were trading above $125 in the international market. However, they mean a 
combined loss of 457 crore per day — a large chunk of which will become the burden of the national exchequer ultimately. Thanks to the subsidised sales the public sector oil industry has lost control over its profitability and hence become unattractive for investment. Public sector petroleum companies like IndianOil, HPCL and Gail India have heavily under-performed the market, while ONGC and Oil India have barely maintained the overall pace. BPCL has been the only outperformer of the league, which is mainly due to its attractive exploration portfolio.
The situation in India's natural gas sector is not looking rosy either. Mukesh Ambani made it clear in RIL's annual general meeting recently that the ongoing problems at KG-D6 block are unlikely to be over within the next 3-4 years.
This means the country's natural gas volumes — growth in which is necessary for growth of transmission companies like Gail — will increase only at a slow pace in the near future. Although some additions can be expected to domestic production, the main growth will come from incremental LNG imports in FY13. Dabhol and Kochi LNG import facilities are expected to commence operations this year and should add 10 million tonne or around 40 mmscmd of additional capacity on a whole-year basis. The actual benefit in FY13 will depend on how soon they commence operations and how fast they can scale up capacity utilisation.



Wednesday, June 13, 2012

OIL SECTOR: Under-recoveries Deny Gains from Price Fall


Crude oil prices have fallen the most globally among all commodities since the start of this fiscal. However, the positives for India are limited because of the rupee's slide. Although petrol prices were recently realigned with costs, the industry’s under-recoveries are poised to top . 170,000 crore for FY13, unless diesel, LPG and kerosene prices are revised.
Data compiled by the Petroleum Planning and Analysis Cell, or PPAC, shows that the cost of India’s crude oil basket fell to $98.1 in the first week of June 2012 after staying above $100 for over six months.
However, a weak rupee means that India’s cost of imports in rupee terms at . 5,445 per barrel was the lowest only since February 2012. After reaching a peak of . 6,230 per barrel in March ’12, it has gradually declined to . 6,110 in April and . 5,906 in May.
Oil companies raised petrol prices recently, yet they continue to be weighed down by major under-recoveries on diesel, LPG and kerosene. The petroleum ministry estimates industry losses at . 12.53 per litre on diesel, . 30.53 per litre on kerosene and . 396 per cylinder of LPG — which no doubt have eased a bit compared to a couple of months ago, but still remain dangerously high.
For the entire industry, these under-recoveries are estimated at . 457 crore daily for the first fortnight of June ’12, down 11.3% from . 514 crore daily in May ’12. At this rate, the total underrecoveries for the ten month period June 2012 – March 2013 of FY13 would work out to . 137,100 crore. If the un
der-recoveries for the past two months – April and May – are also taken into account, the whole year’s under-recoveries would be close to . 170,000 crore.
India imports 83% of its crude oil requirements annually. The country’s provisional crude oil import during 2011-12 was 172.11 million tonne. This was 5% more than the crude oil import of 163.59 MMT in 2010-11. A total of 204.8 MMT crude oil was processed by Indian refiners in 2011-12 against 196.5 MMT in 2010-11.
There are already indications that the slide in world oil prices may not continue further. Saudi Arabia has hinted at scaling down its output, while raising official selling price of its main Arab Light grade from July onwards. At the same time, Iran’s talks with the UN Security Council members are dragging on without any definite solution in sight.
Against this backdrop, the rising under-recoveries of the petroleum sector and also the subsidy burden for the national exchequer are worrisome. Any step by the government to address this issue will have a positive impact on the country’s currency as well as sovereign ratings.

Tuesday, June 12, 2012

Aarti Inds Rides High on Growth Plans, Attractive Valuations



Mumbai-based specialty chemicals maker Aarti Industries has seen its stock price nearly double to a 52-week high as the company posted a 27% profit growth in FY12 after two years of stagnation. What also appears to have helped is that the promoters raising their stake to 53.97% from 50.07% during the last three quarters. With crude prices softening and the rupee remaining weak, the company’s expansion plans and inexpensive valuations seemed to have attracted investor interest.
Aarti Industries is a leading manufacturer of benzene-based specialty chemicals & pharmaceuticals with diversified end-users in industries such as pharmaceuticals, agrochemicals, polymer, additives, surfactants, pigments and dyes. It occupies the top to fifth slot for the majority of its key products globally. It counts most global majors such as DuPont, BASF, Clariant, Huntsman, Unilever and Pfizer among its clients. The company operates in four segments — with the biggest segment being performance chemicals, which contributes 58% to its total revenues, while smaller segments such as home and personal care chemicals, agrochemicals and pharmaceuticals contribute the rest.
During FY12, the company upgraded its hydrogenation technology and doubled ca
pacity to 1,500 tonne per month (TPM). In FY13, it plans to set up its own captive hydrogen generation plant, which will double its output of hydrogenated compounds to 3,000 TPM, which enjoy better margins.
The company is also expanding its pharma business, which contributes 10% to its revenues at present and has achieved a breakeven for the first time in FY12. It exports 4 active pharmaceutical ingredients to the US and 16 to Europe from its two USFDA-approved plants and expects a couple of more approvals in 2012. Besides, the 
recent fall in crude oil prices has helped the company by way of lowering raw material costs, while depreciation in the rupee is good for its exports, which accounts for 42% of its total sales.
In the last five years, Aarti Industries’ net sales grew at a compounded annual growth rate of 17.9%, while 
net profit grew at 32.5%. The company has maintained its operating profit margin between 12.3% and 16.8% during the last five years.
The company has two main problems. First, since it makes prompt payments on raw material purchases, its working capital has gone up with the turnover. Also the management has always maintained a policy of consistently paying dividends every year rather than conserving cash for debt repayments.
This has resulted in a bloated debt of . 588 crore at the end of March 2012, which was 
almost equal to its net worth. For FY12, its interest burden stood at . 72 crore, with interest coverage ratio below 3.
Second, the company operates through a number of subsidiaries and joint ventures where the promoters hold stake in their personal capacity. This could raise corporate governance concerns. Nevertheless, the company has already taken steps to merge all these businesses into one and plans to merge this associate company with itself during FY13. Such a step would be a big positive for the company.
Aarti Industries is trading at 6.2 times its earnings for last 12 months, but is still below book value. The company paid . 2.5 per share as dividend in FY11, which translates into a yield of 3.5%. The company needs to take swift steps to address its problems to sustain and improve its current valuation. 


Tuesday, June 5, 2012

INDRAPRASTHA GAS: Prolonged Legal Battle, Margin Pressures Loom

The relief rally in Indraprastha Gas after the company won a high-profilelegalbattle against gas regulator PNGRB appears to have run its course. After gaining 30% on Friday, the stock has lost 5.4% on Monday in an otherwise positive market, falling to near half of its 52-week high. Analysts arewarning investors not to take IGL’s legal win too seriously. “We do not believe this is the end of the battle as the regulator is likely to appeal to higher courts,” says Rohit Nagaraj, research analyst, Centrum Broking. Itwas mainly the prospectof a prolonged legal battle that prompted investors to dump the stock on Monday. However, the regulator doesn’t seem to have made up its mind yet. “We have not taken a final decision on approaching the Supreme Court,” S Krishnan, chairman, PNGRB, told ET. At a conference call arrangedby a Mumbai-basedfinancial services firm, apparently a former member of PNGRB agreed that the regulator has no power to determine the “final price” of gas. Approaching the Supreme Court or getting the PNGRB Act amended are the two options before the regulator.
How should a retail investor interpret all these? A Kotak Institutional Equities report says that IGL’s margins are bound to fall in future even if the final selling price of gas is not regulated. It says IGL’s rich valuationsfactor in high ROEs and growth in perpetuity. The brokerage sees significant risks to this even if network tariffs and compression charges for gas are not regulated. Investors would be better off shunning the stock until there is clarity. 


Monday, June 4, 2012

OPERATING MARGINS A BRIGHT SPOT


Revenue Growth in Q4 Slowest in Over 2 Years

India Inc’s revenues grew at their slowest pace in more than two years, stung by a slump in investments, policy inertia and rising cost of inputs, according to an ET study.
An analysis of 2,302 listed companies shows a 13.5% year-on-year revenue growth for the quarter to March, as against 19.3% in the December quarter and 17.8% in the three months to September. The analysis, which excluded companies in the finance and petroleum sectors, covered performances for the last 13 quarters. But it is not all gloom and doom. The analysis also shows that firms recorded an improvement in operating margins and debt servicing.
India Inc’s operating profit margins improved from the December quarter, as did the interest coverage ratio — a matrix that measures a firm’s ability to pay interest on borrowings. 
Even the year-on-year fall in net profit was lower in the March quarter, compared with that in the previous two quarters.
Although both operating profit margin and interest coverage ratio were below the year-ago figures, the levels reflect a pause in the downtrend in companies’ margins and profitability throughout 2011.
The biggest challenge for Indian companies, the study notes, is the slowdown in revenue growth.


 Net Profit Fall Lower Than Q2 and Q3 
The slowdown in revenue growth coincided with the disappointing March-quarter GDP growth. GDP rose 5.3% in the three months to March from a year ago, the lowest in nine years, dragged down by a moderation in services and consumption. “Sales growth has slowed down in the last quarter of FY12, reflecting the slowdown in GDP growth. We expect it to be on a slower trajectory in FY13, vis-àvis FY12,” said Bhupinder Sethi, head of equities at Tata Asset Management.
According to the study, India Inc’s interest costs in the March quarter jumped 47.4% to . 30,123 crore, a record high at 3.47% of 
revenues. It was also the eighth consecutive quarter of high, double-digit rise in interest costs.
On the brighter side, the Marchquarter net profit for the companies under review was down only 8% from the year-ago period, marking an improvement over the 20.6% fall in the December quarter and 37.9% drop in the September quarter. India Inc’s operating profit margins for the March quarter stood at 14.3%, an improvement from the preceding two quarters, but down 200 basis points from the previous corresponding quarter. One basis point is one-hundredth of a percentage point.
The interest coverage ratio stood at 3.8, which was higher than the preceding two quarters 
but down 170 basis points y-o-y. The ratio had dipped to 3.4 in the December quarter. Tata Asset Management’s Sethi said, “While margin pressures seem to have bottomed out, finance costs have impacted bottom lines. Companies with leveraged balance sheets may thus continue to see pain for some more time.” Exportoriented sectors should do well in FY13, he added.
With two months into the June quarter, two key events — over 
10% depreciation in the rupee and the Reserve Bank’s 50-bps cut in interest rates — are set to impact corporate performance for the quarter. Birla Sun Life Asset Management CEO A Balasubramanian said, “We expect business pressures to persist in the first half of FY13. If interest rates were to ease, as is anticipated since the RBI is now expected to support growth, there will be a revival in sentiments and the investment cycle can then pick up from the second half.”
But not everyone believes the pain is over yet. “I am not very optimistic about the broader environment,” said Kenneth Andrade, head of investments at 
IDFC Asset Management. “Even if the government swings into action, we still have challenges. The economy is slowing at a fast pace, there are concerns on order books, capital expenditure has come to a grinding halt,” Andrade said, adding, “Even though consumerism has not faced much of a problem yet, it may also slow down if the overall economic situation fails to improve.”