ESSAR OIL: Debt Remains a Worry Despite Improved Show

Essar Oil’s search for solace isn’t likely to end soon as its huge pile of debt continues to prove a drag on financial performance, even as the company is doing better operationally. September quarter numbers show a little improvement, but it needs to be seen whether this can be sustained. In other words, investors will need to be patient. With interest payments eroding earnings, what Essar Oil requires is either a sustainable spurt in operating cash flows or a restructuring of its debt burden. The company has been working on both these aspects for several months but it is taking much longer than earlier anticipated. Total net debt at the end of September was almost the same as it was six months before, but net worth — shareholders’ funds — stands eroded. Plans to raise dollar-denominated debt to repay that denominated in rupees to lower interest costs and extend the tenure also didn’t make much progress during the quarter. It converted loans worth just $50 million; it needs to raise an additional $1.4 billion. Nevertheless, the company’s ability to generate free cash flows could be improving, as it has put up a strong operating profit show, while interest costs appear to have softened. On a sequential basis, operating profit was up almost 45% to . 1,595 crore, while interest costs dipped 19% to . 766 crore. These two key trends need to be sustained. Foreign exchange losses of . 773 crore saw the company post another net loss in the September quarter. Gross refining margin (GRM), the differential between the price of refined products sold and the cost of crude oil needed to produce them, slipped to $6.93 per barrel from $7.86 in the year ago. The company is betting on improving GRM in coming months to ease its cash flow position further, while continuing to push for the conversion of rupee debt to dollar debt. The global outlook for the refining industry doesn’t appear rosy with capacities getting added while demand growth is muted. Essar Oil, therefore, needs to achieve the debt conversion goal at the earliest to relieve some of the pressure on earnings. Investors will have to wait till the company starts making sustainable profit.

CAIRN INDIA: Lower Realisations, Worries Over Output Growth to Weigh

Exploration firm Cairn India’s earnings in the quarter to September failed to impress investors despite a 46% growth in net profit. That is because the company reported an unexpected drop in realisations, while output growth was muted. Cairn India’s ability to achieve production growth will hinge on timely regulatory approvals. Cairn’s production from its Rajasthan fields averages 174,245 barrels of oil (bopd) daily, which is just 1% above the April-June ’13 quarter. However, this is much lower than the 180,000 bopd rate the company reported in July, when it announced its Q1 FY14 results. This has stoked concerns relating to further production growth, inspite of the company maintaining its year-end production guidance of above 200,000 bopd. A note from India Infoline said that despite Cairn India bringing 26 new wells into production, volumes in Rajasthan were stagnant QoQ. The wells — Mangala and Aishwarya — produced 152 thousand barrels per day (kbpd), indicating a decline in Mangala at around 145 kbpd, while Bhagyam produced 23.5 kbpd, short of the approved 40 kbpd plateau, the note said. Apart from concerns about the natural decline at the biggest field – Mangala, there are worries about the second largest field Bhagyam as well. A report from Nomura points out that over the last one year, Cairn drilled 13 additional wells in the Bhagyam field, but without any increase in production volumes. The report says that while 79 of FDP-approved 81 wells are drilled, production is well below FDP-approved rate of 40 kbpd. The Field Development Plan, or FDP, is the government-approved plan of action with specified deliverables and costs. Another negative was the lower realisations for Cairn’s crude oil. The Rajasthan realisation stood at $96 per barrel, implying a discount to Brent at around 13% as against 8.3% in the April-June period and 11% in FY13, due to a weakness in fuel oil prices. The company’s progress in ramping up production will depend on timely approvals from its JV partner ONGC as well as the government. It has received approvals for drilling 48 infill wells in Mangala and 18 in the Bhagyam field, while it awaits approval to launch an Enhanced Oil Recovery programme in Mangala and FDP to develop Barmer Hill reservoir. Cairn also continues to explore in the Rajasthan block for incremental resources. Investors will keenly watch progress on these fronts to raise production.

CASTROL INDIA: Volume Growth Poses a Challenge

Castrol India surprised the Street with a strong 21.9% spurt in net profit in the July-September period despite the rupee and oil price volatility during the quarter. However, the company faces challenges with volume and revenue growth remaining stagnant. Operating profit rose 23.4%, thanks to margins widening by a dramatic 3.9 percentage points. The company’s fortunes have traditionally been tied to that of the commercial vehicles segment which, in turn, has been doing poorly because of the economic slump. Nearly 75% of Castrol’s 200-million litre volume is accounted for by commercial vehicles. On the other hand, in the personal mobility segment – two-wheelers and passenger cars – volume is growing at 10%. The wider margin is ascribed to this segment share shifting. “The stagnation in turnover is not abig concern, since it is not due to Castrol losing market share or its customer base,” managing director Ravi Kirpalani told ET. “We are improving our market share in passenger vehicles. Our rural initiative has added 9,000 new customers and 3 million litres of volumes of incremental sales in the last one year.” The company cut costs in areas such as advertising and promotion during the quarter, which also helped expand its margins. Castrol introduced RX Super Max Fuel Saver during the quarter, promoting it as the world’s first diesel engine oil recommended for fuel efficiency by a vehicle maker -- Tata Motors. “This engine oil is designed to increase fuel efficiency of Tata trucks by 1.5%. This means for a truck running 100,000 km per annum, it will save 375 litres of diesel, or 20,000 in running expenses,” Kirpalani said. The market’s reaction to the earnings was muted, given the likelihood of margin pressure on December quarter numbers as rupee and oil price fluctuations in August are likely to have a delayed impact on results.

PETRONET LNG: Underutilised Kochi Terminal, Pipeline Issues are Big Worries

The drop in profits of Petronet LNG in the quarter to September has already been discounted by analysts considering that the company had capitalised its underutilised Kochi terminal during the quarter. But the performance in the last quarter indicates that some of its operating challenges will not be easy to surmount in the near term and the stock is likely to underperform over the next three to six months.
Petronet LNG, which imports and sells liquefied natural gas (LNG) to local firms and has two terminals, encountered multiple headwinds during the quarter. A bout of rupee volatility resulted in a lower demand for imported natural gas leading to a 9% y-o-y drop in volumes to 123 trillion British thermal units (tBtu). Its long-term volumes were up 9% to 98 tBtu, but tolling and spot volumes were down 31% and 55% at 12 and 12.5tBtu, respectively. This translated into a 30% drop in operating profit at . 363.9 crore.
The company also commissioned its new 5-million tonne import terminal at Kochi during the quarter, which boosted its depreciation charge by 27.7% and interest burden by 22% from the year-ago levels. This led to a 40% drop in profit before tax and close to 42% at the net profit level, thanks to a rise in the effective tax rate.
The capacity utilisation at the new Kochi import terminal is going to be a big worry for the company due to the lack of adequate pipeline connectivity. The expected commissioning of the Kochi-Mangalore pipeline has been pushed to October 2014, compared to May 2014 earlier. There is no clarity on the Mangalore-Bangalore pipeline too. Until these pipelines become functional, the Kochi terminal’s capacity utilisation will remain below 10%. This will depress corporate earnings due to higher depreciation and interest costs. During the July-September ’13 period, the Kochi terminal incurred a loss of . 32 crore before tax, even though the terminal has been recognised as an asset in the books of accounts only from September 10, 2013. From the quarter to December this year, as interest and depreciation on this asset will be booked for the full quarter, it will put greater pressure on the company’s profitability.
Petronet LNG plans to add one more jetty at its Dahej terminal by May ’14, which would enable it to import 1.25 million tonne more annually. Similarly, its project to expand the Dahej terminal’s capacity by adding two more storage tanks will take 36 months to operationalise.
Most brokerage houses, including Kotak Securities, Motilal Oswal, Karvy Broking and Religare, remain bullish on the company’s future prospects with target prices ranging from . 142 to . 165 due to low valuations and on expectations that the domestic shortage of natural gas will favour Petronet LNG. Another brokerage Centrum Capital took a contrarian view recommending a ‘Sell’ on the stock with a target price of . 110 as the company “faces multiple headwinds which would lead to earnings pressure.” Investors should be cautious since the stock lacks any near-term positive trigger, while facing the challenge of pressure on profits. 

BPCL: Is it a Refining Stock or an Exploration Play?

While private sector companies are known to take that extra risk, diversify into newer areas even at the risk of inviting investors’ wrath, stateowned companies are happy in their comfort zone, anchored in their traditional businesses despite holding the biggest chunk of idle cash in the corporate world.
It’s in this context that state owned Bharat Petroleum’s gradual but successful move into the exploration & production (E&P) space needs to be looked at. After all, E&P business is vastly different from refining and marketing, although they form the same value chain.
In the next five years, the company will start earning much higher profits from its E&P business than the government-sponsored profits it can earn from its traditional business.
In 2010 huge natural gas deposits were discovered in a Mozambique offshore block. BPCL’s 10% stake in it is already worth over $2.2 billion, or half of the company’s value today. 
BPCL also holds between 10% and 20% stake in 10 blocks in Brazil, which have seen some exciting oil discoveries over the years. Although not certified yet, they are likely to be significant going by the technical details available.
By 2018, both these mega projects begin production, BPCL is likely to have a bigger source of profits than its conventional businesses.
Experts are already valuing the E&P portfolio steeply. In fact, most brokerage houses prefer BPCL as an investment candidate for its E&P success.
“BPCL remains our top pick,” mentioned a Barclays report in May 2013 attributing the preference to its undervalued E&P portfolio.
The oil reserves in Brazil will be known in the first half of 2014, according to a Motilal Oswal report. “Assuming the recoverable reserves at 500 mmboe, it is likely to add around 50 to BPCL’s share value,” it mentioned.
As more details trickle in, this changing face of BPCL will turn it into a winner for investors.

SINTEX INDUSTRIES: Lower Debt Key to Help Sustain Dramatic Rebound

The stock of Gujaratbased plastic goods m a k e r Si n te x Industries apears to be rebounding after hitting an all-time low of 16 last month – down more than 70% from a year ago. Over the past one month, the stock has reversed its direction, and its recent results appear encouraging.
    A key growth driver earlier, the company’s business contrac ted consistently over the past three years owing to delayed payments. This grew 8.7% to 263.3 crore during the quarter to September, which was cheered by investors. The other businesses — prefabricated structures, customs moulding and textile are doing reasonably well.
    Yet, the company needs to do a lot more. Its debt-equity ratio has not improved during the past six months. In fact, its net debt has gone up marginally while its interest cost for the quarter to September at 47 crore was the highest ever it paid in a quarter.
    If the euphoric run-up in the scrip has to continue, Sintex will need to improve on these parameters.

RIL’s Q2 Other Income Falls, But Still Too High

Changes in balance sheet or asset creation seen as more relevant to driving the company’s future growth

The earnings of Reliance Industries in the quarter to September were in line with analyst expectations and devoid of any surprise. As India’s second most valuable company maintains stability in its quarterly earnings, the changes in its balance sheet or asset creation will be more relevant to drive future growth. 

RIL has once again embarked upon an aggressive capital expenditure programme after it had added assets worth nearly . 25,000 crore in FY08-09. In the six-month period to September 2013, the company has already incurred a capital expenditure of . 20,154 crore, overshooting its FY13 capex of . 19,041 crore.
The higher capex has led to the company’s debt rising 16% from . 72,427 crore in March 2013 to . 83,982 crore at the end of September this year. The company continues to retain its cash-rich status However, the excess of cash over debt has dropped from . 10,548 crore at the end of March 2013 to 6,558 crore at the end of September this year.
In the September quarter, RIL reported a weaker performance in the refining segment with lower refining margins, while the petrochemicals division posted a robust performance, negating the impact of the lower refining margins. Other income, or income from sources other than the core business, at 2,060 crore were substantially lower compared to 2,535 crore in the quarter to June. This means the non-operating income now contributes just 30% of the company’s pre-tax profits as compared to 38% of previous quarter. This may be considered good for the company since the proportion of operating businesses in overall profitability has gone up. However, other income’s influence on profitability is still too high.
The company reported a sharp drop in polymer demand growth in India to just 1% year-on-year in the July-Sept quarter from 15% of April – June 2013. Growth was subdued and the anticipated festive season demand did not materialise fully, said a company release. Such a subdued demand growth, if it persists, could stoke concern, especially in view of capacity additions which the company is planning.
The results are unlikely to provide any direction to the company’s stock price, since they met most analyst estimates. “There was no surprise in RIL’s numbers. The markets have already factored in the results,” said Dhananjay Sinha, head of research with Emkay Global Securities. However, any updates the company’s management shares with brokerage analysts about its capex plans and timelines in a late evening meeting could influence the performance of the stock in the near term.

RIL Unlikely to Surprise as Refining Margins Weak

Co likely to post GRM of around $7.8/barrel, down from $9.5 year-ago period

Although Infosys has begun the quarterly results season with a bang, the next most-keenly awaited result of Reliance Industries is unlikely to create such a stir. The second most valuable company in India is likely to maintain its profitability from the previous quarters with the most aggressive estimates pegging the profit growth at a meagre 2.7% year-on-year.
RIL’s performance for the July-September 2013 quarter will be bogged down by a lull in the regional gross refining margins (GRM). Reuters’ Singapore benchmark GRMs were down to a 12-quarter low of $5.4 per barrel during the latest quarter, according to a report by Merrill Lynch.
RIL is likely to post GRM of around $7.8/barrel, down from $9.5 of year-ago period and $8.4 of the immediately preceding quarter. GRM is the differential between sales proceeds of refined petroproducts and cost of crude oil needed to produce them.
There won’t be anything new in the company’s ailing E&P business, which should post over a 50% drop in profits compared with a year-ago period. The company’s KG basin gas production, which was around 15 mmscmd in the April-June quarter, is likely to have dropped below 14 mmscmd.
Similarly, the production from Panna-Mukta-Tapti (PMT) fields is also on the decline. The third key business segment of the company — petrochemicals — is expected to do much better with a margin expansion, thanks to a spike in prices and a rise in domestic customs duties since May 2013. The July-September quarter could have turned much worse for the company, but for two important macroeconomic drivers. The rupee turned extremely volatile and ended nearly 12% weaker from the previous quarter.
This means its GRMs, although lower in dollar terms, should translate into a better number in rupees. Also, the resultant jump in crude oil prices from . 5,750 per barrel in the April-June 2013 quarter to . 6800 in July-September quarter will bring some inventory gains.
Similarly, the gas and oil it produces will fetch more in spite of lower volumes. The domestic interest rates soared during the quarter with the yield on benchmark 10-year government bonds briefly crossing 9% during the quarter. The average yield for the quarter was almost 100 basis points higher than the April-June quarter. This should boost the company’s other income, which has long emerged as a key source of its profits.
The RIL scrip has under-performed the BSE Sensex since its last quarterly results, although its profit for the April-June quarter was at the top-end of street expectations. A similarly dispirited performance could continue even after this result unless the company offers clarity on the progress of its various expansion projects. 

Weaker Rupee to Prop Up Oil Majors’ Refining Margins

But subsidy burden could offset any such gains for upstream public sector oil majors

The July-September 2013 quarter was volatile when it came to the rupee and crude oil prices – two crucial factors that impact the sector most. Volatility kept demand low, putting pressure on margins. However, benefits of rupee depreciation and higher interest rates should prop up the numbers of private sector players such as Reliance Industries and Cairn India.
The rupee weakened almost 12% during the quarter ending at 62.5 against the dollar after moving between 59 and 69, while international crude oil prices rose 6.3% to $109.8 per barrel on Syria tensions. This has caused the under-recoveries for the public sector retailers to jump, which is estimated between . 34,600 and . 37,500 crore, compared with . 25,579 crore in the April-June 2013 quarter. This means IndianOil, BPCL and HPCL could end up with huge losses if the government limits its compensation.
The performance of upstream majors such as ONGC and Oil India will depend on how much subsidy burden they are made to bear. If the burden remains at $56 per barrel in line with the previous quarter, ONGC and Oil India are likely to benefit from the rupee depreciation and post better profits.
When it comes to refining companies, the gross refining margins (GRMS) — the difference between product prices and cost of crude oil needed to produce them — were under pressure, but the rupee depreciation and inventory gains should compensate for the same.
“In Q2FY14, Singapore complex GRMs were under pressure and declined by 17% quarter-on-quarter, averaging $5.4 per barrel,” mentioned a report from Kotak Securities. The GRMs for Reliance Industries – a keenly watched number — is estimated around $7.8 per barrel for the quarter, down from $8.4 posted in the preceding quarter. However, this should translate into a higher rupee figure due to the currency depreciation. The natural gas industry is likely to continue its subdued performance, thanks to dwindling domestic production and rupee depreciation leading to high cost of imports. GAIL’s volumes are likely to drop to 98 mmscmd during the July-September ’13 quarter from 99 mmscmd of the last quarter. Better realisations in petrochemicals and LPG businesses could offset this, provided the subsidy share remains at . 700 crore.
Petronet LNG’s volumes are likely to take a dip in the July-September quarter at its Dahej plant as prices spurt, while commissioning of its Kochi unit would add to its interest and depreciation costs. Both these factors would result in a drop in its profits. In contrast, city gas distribution companies Indraprastha Gas and Gujarat Gas are likely to show some resilience due to their recent price rises.
On this background, the clear winner for the quarter is likely to be Cairn India, which will show healthy profit growth, thanks to higher production, benefit from the rupee depreciation and higher oil prices. Similarly, its surplus cash will generate better returns because of higher prevailing interest rates during the quarter.

PETROL CONSUMPTION: Appetite Grows

Defying the widely accepted economic theory that rising prices curb consumption, use of petrol in India has actually grown at a healthy pace in the last three years of price deregulation. The slowdown in economic activity, which has affected consumption of other liquid fuels, hasn’t actually impacted petrol.
While consumers expressed their displeasure – at times, even anger – at rising prices, it didn’t deter them from using the fuel. Petrol prices at retail outlets in Mumbai have risen from 52.2/ litre in April 2010 to 79.5 at present, according to Indian Oil – a jump of 52%.
Nevertheless, in the same period, petrol consumption has increased from 12.8 million tonne in FY10 to 15.7 million tonne in FY13, and is estimated to reach 16.5 million tonne during FY14, according to Petroleum Planning and Analysis Cell. This translates into an annualised volume growth of 6.6%.
During the first five months of the current fiscal (April- August), petrol consumption grew 11.7% against the year-ago period even when regulated products like diesel, LPG and kerosene together witnessed a 1.4% drop year-on-year.

Projects on Finishing Line to Boost MRPL’s Margins

It was a coincidence that the shares of Mangalore Refinery & Petrochemicals (MRPL) hit the lowest level in a decade recently, when it has just completed 10 years under ONGC. The scrip is in the recovery mode of late, indicating its woes are over.
MRPL’s market cap dipped below . 5,000 crore mid-August 2013 from a peak of over . 25,000 crore in December 2007 and almost 40% below its valuation at the peak volatility of mid-2008. The reason was its consistent inability to post profits.
MRPL suffered losses for FY13 as well as in the first quarter of FY14. The reason was a drop in refining margins due to the delay in its expansion project as well as volatility in oil and rupee movements. The company completed its expansion project last year, but still some of its units have not commissioned operations due to over an 18-month delay in finishing the captive power plant. Things are likely to improve from the present as it aim to commission the power plant by October 2013. This will enable it to run its critical units necessary to useheavy and high sulphur types of crude oils, which are available cheap. Once stabilised, these units could add $3 to its gross refining margins – the difference between cost of crude oil and price of refined products it sells.
The company also commissioned its single point mooring (SPM) project 16 km from the shore for handling very large crude carriers (VLCCs). This will not only bring in freight economies, but also allow access to crude oils from far off places like West Africa and Latin America. Both these factors will be positive for its GRMs.
The company is also nearing completion of its 440,000 tonne per annum polypropylene unit, which is expected to commence operations in early 2014. This will be further add value to its petrochemical products and improve margins.
Cumulatively, all these developments are likely to improve MRPL’s operating profit margins substantially from the Jan-March 2014 quarter onwards. This has already started reflecting in the company’s market performance. The scrip has gained nearly 30% from its bottom in the last one month.
The company’s debt-equity ratio stands below 1 and it has further expansion plans. Considering ONGC’s parentage, the company is unlikely to face any long-term problems for reasons such as lack of funds. Currently trading at less than its book value, the company can be a value creator for long-term investors.

HINDUSTAN PETROLEUM: No Redemption

Although the three state-owned petroleum retailing companies face similar problems, Hindustan Petroleum (HPCL) has consistently under-performed BPCL and Indian Oil. There is little to suggest that the company may outperform its peers in the near term. There are enough reasons for such an assessment. BPCL holds a successful E&P portfolio supporting its valuations while Indian Oil has gained from its large size and exposure to petrochemicals.
On the flip side, HPCL has emerged as the one which is highly dependent on government subsidies and discounts due to its significant reliance on traded goods — the quantum of petroleum products bought from other refiners at market rate to sell through its own outlets.
Nearly 59% of its FY13 revenues came from traded goods, while for BPCL this proportion was 52% and for Indian Oil only 42%. HPCL’s balance sheet is also the weakest among the three with a debt-equity ratio above 3. The company’s future plans don’t suggest this will change soon.