Issues with Govt Still Weigh on RIL

Index heavyweight Reliance Industries continues to underperform the broader benchmark index Nifty 50 even in FY14, continuing its subdued trend over the past four fiscals. Although brokerage houses have started revising their views in the past four months, the stock remains range-bound due to a few concerns. Investors will do well to wait and watch.
Despite a significant weightage on benchmark indices such as Nifty 50 and the BSE Sensex, Reliance Industries has gained just 1% during the past three months, against the 11.5% gain in the Nifty and 10.4% in the BSE Sensex. A Bank of America Merrill Lynch report said that RIL stock price has underperformed the BSE 30 by 98% since April 2009 due to its weak EPS growth (CAGR of 4% for FY08-13) and de-rating of its E&P. Even after its continued underperformance, analysts in brokerages have been bullish, of late.
According to data compiled from Bloomberg, just 50% of 56 brokerage analysts tracking the company had a ‘Buy’ recommendation at the start of September 2013. This has gone up to over 62% now. However, the improvement in ‘Buy’ recommendations has not been supported by any improvement in the target price. The average one-year forward target price was . 975 – or 14.3% above the then prevailing price – at the start of September, which stands at . 985 – or 13.2% above its closing price on Thursday. In other words, analysts are being bullish without really raising the target price.
This could be interpreted as an improvement in terms of visibility over future earnings, but earnings growth itself will be high. RIL has embarked upon an expansion programme and expects doubling of natural gas prices starting April 2014 and its forays in retail and telecom are close to reaching critical mass.
A Morgan Stanley report said that RIL is set to double its profits over F13-17e driven by higher gas prices and volumes and downstream expansion, with one of the most aggressive price target of . 1,156, or 33% above the current level. These bullish recommendations apart, investors are not biting owing to anumber of concerns. Concerns on implementation of the gas price increase and RIL’s dispute with the government on ‘cost recovery’, besides a weak outlook in refining margins over the next couple of years are reasons to worry. The BoAML report said that RIL’s FY15-16e GRM could be significantly lower than assumed and its gas price may not be hiked in April 2014. In that case, RIL’s FY14-16e EPS CAGR may be much lower – at 2-12% – as compared to our base case of 17%, it warns. Retail investors would be better off waiting for more clarity on these issues . 

GUJARAT GAS: Sept Show won’t be Sustainable

Gujarat Gas reported a 19.7% jump in profit to . 119 crore for the quarter to September. This is by far the highest quarterly profit posted by the private sector natural gas distribution company. But analysts say the company will not be able to sustain the high profit in the quarter to December. They have given a “Hold” call on the stock. Gujarat Gas, however, still holds the potential to generate value for investors. The company is focusing on improving margins and expects volumes to rise in the coming months. One of the main reasons behind the high profit growth at Gujarat Gas was its all-time high gross margins at . 9.4 per standard cubic metre. The resultant operating profit margin increased to 23.7% from 19% in the year-ago quarter. This was a result of one-time favourable developments. “We decide on pricing based on our projection of natural gas costs and volumes,” Sugata Sircar, managing director at Gujarat Gas, told ET. “During the September quarter, the availability of local gas was higher than expected, reducing the use of imported LNG to 48% against 50% in the nine months to September.” As a result, the cost of raw material for the company turned out to be lower than anticipated, which boosted its margins. The company has also managed its other operating costs well. The company’s performance over the past few quarters has underlined its focus on maintaining and improving profit margins by aggressive price hikes. The company last raised the price inOctober anticipating higher LNG prices during the winter season. Gujarat Gas also maintains that its stagnating volumes should not be seen as a long-term handicap. “Every quarter, we are signing new volumes with industrial clients while CNG and PNG customers are increasing. However, volumes would drop if clients switching over to grid power were higher,” said Sircar. The September quarter saw the situation changing as the company posted a marginal increase in natural gas volumes. An improvement in the industrial scenario and beginning of the new investment cycle should firmly reverse the declining trend in volumes. “We have bottomed out in volume terms,” Sircar said. Gujarat Gas will have a cash balance of nearly . 600 crore even after paying . 9 a share interim dividend announced by it. Considering it will generate . 350-400 crore of cash annually with capex requirements just one-third of that, its cash pile will continue to bulge. At 11 times its earnings for trailing 12 months, the company’s stock appears attractively valued for long-term investors.

Output, Subsidy Woes to Worry ONGC

The depreciation of the rupee helped ONGC, India’s biggest oil and gas explorer, post better-than-expected results in the September. quarte. The state-run explorer, however, continues to suffer from ad hoc subsidy sharing and stagnating production. Net profit at ONGC rose 2.8% yearon-year to . 6,064 crore, despite a 12% spurt in the subsidy burden to . 13,796 crore. This was made possible mainly by the more than 12% year-on-year depreciation in rupee during the quarter.
For every barrel of oil that ONGC sold, it recovered . 2,786 even after offering a $64.2 per barrel discount to oil marketing companies under a government diktat. This was 7.9% higher compared with the year-ago quarter. Being the biggest oil company, ONGC has to share the maximum subsidy burden.
While ONGC gave a subsidy of $64.2 per barrel during the quarter, Oil India offered $56 per barrel. It was also higher than the $62.9 per barrel discount it extended to downstream oil marketing companies in FY13 and $62.7 per barrel discount it offered in the quarter to June.
Although production has been lagging ONGC’s own expectations for some time, the September quarter did see some improvement in output. While crude production was stable at 5.1 million tonne, natural gas output was up 1.4% to 5.9 billion cubic metre.
The company’s depletion and depreciation expenses rose nearly 47% to . 2,427 crore, but a slow rise in rest of the costs led to a muted 11% growth in total expenditure. However, markets are likely to cheer the company’s ability to post a more than 50% growth in profits over the previous quarter. The positive sentiment, though, is likely to be short lived as the worry over ad hoc subsidy sharing still persists.

India to Drive Global Oil Demand by 2020

By 2035, India will consume more oil than Japan, Australia and Korea combined, says IEA chief economist

India is set to become the biggest driver of global oil demand by year 2020,” claimed International Energy Agency’s chief economist Fatih Birol while speaking to ET on Tuesday. “Year 2020 is like tomorrow, from the oil industry’s point of view,” he said, underlining the urgency in his message on the sidelines of the publication of IEA’s World Energy Outlook 2013. 

The Paris-based International Energy Agency (IEA) came out with its annual take on the energy industry’s outlook on Tuesday. Set up by the Organisation for Economic Cooperation and Development (OECD) as a response to the oil shock of 1973-74, IEA advises its 24 member countries on issues related to energy security. IEA’s well-researched monthly as well as annual reports on the energy industry are regarded as unbiased and referred by policy makers, industry as well as academia.
IEA’s World Energy Outlook 2013 predicts the global oil demand to reach 101 million barrels per day (mbpd) by year 2035 from today’s around 87 mbpd. This is a significantly modest projection compared with 108.5 mbpd predicted by the Organisation of Petroleum Exporting Countries (Opec) in its World Oil Outlook published last week.
“There are various estimates available for future global demand, which differ based on the assumptions made,” Birol said. “One reason our estimate is lower maybe because we take into account the effect of current and likely energy efficiency policies by the governments, which will slow down consumption growth,” he reasoned.
The World Energy Outlook 2013 projects global coal consumption to grow 17% by year 2035 while the oil consumption is expected to grow nearly 16% from current levels. Natural gas consumption is expected to grow fastest mainly due to sharp growth in emerging economies such as China. While the high-paced growth in the shale gas and oil output will continue to transform the industry globally, conventional oil production is expected to stagnate to 65 mbpd.
“This does not mean the world is on the cusp of a new era of oil abundance,” cautions the report, which predicts a $128 per barrel price for crude oil till 2035, excluding any impact of inflation. Major oil industry investments during next 20 years will go in trying to maintain the output from existing oil fields. By 2035, transportation and petrochemicals will remain the only two demand drivers for oil. The size of India’s economy and growing population means the country will need more and more energy to continue its growth. Around a quarter of incremental oil demand globally will start coming from India alone post 2020. Similarly, by that time India will be world’s single largest importer of coal, according to IEA’s World Energy Outlook 2013.
“India’s oil consumption will exceed 8 mbpd by 2035, which is more than current consumption of Japan, Korea and Australia combined,” explained Birol.
India faces the challenge of ensuring access to affordable energy in the long-term while minimising the environmental impact.
“For a country like India, policies to improve energy efficiency are most necessary in transportation or electrical ppliances etc,” he added. According to him, India’s coal-based power plants have one of the lowest efficiencies in the world. “Making use of renewables, wherever economically feasible and increasing the share of natural gas,” were the two other measures he suggested. For a country like India, which has grossly neglected the health of its energy sector, thanks to unsustainable subsidies, this report should come as a wake up call. To sustain its economic growth and well being of the ever growing population, bold reforms are called for in the energy sector. 

For a country like India policies to improve energy efficiency are most necessary in transportation or electrical appliances, etc. I also suggest making use of renewables, wherever economically feasible and increasing the share of natural gas 

DR FATIH BIROL
Chief Economist, International Energy Agency

Oil India Likely to Gain if Gas Prices Rise Next Fiscal

Oil India’s financial performance in the quarter to September did not throw much of a surprise as a higher subsidy burden and an increase in depreciation and depletion cost eroded any benefits derived out of rupee depreciation. Profit, however, was better than in the preceding quarter, which boosted the company’s share price. Dry wells and depletion costs are key to any exploration and production firm, since other costs do not fluctuate much. For Oil India, this cost nearly doubled over the year-ago quarter to . 465 crore, its highest level so far. Similarly, subsidy burden for the quarter was 7.5% higher YoY to . 2,234 crore. The company’s oil and gas output has for long suffered stagnation because of agitations in the northeastern states, where it has most of its operations. Its oil production fell 4.6% to 0.92 million tonne while natural gas production declined 3.5% to 0.67 billion cubic meters during the quarter. Rupee depreciation, however, helped Oil India maintain its profitability at a decent level. The company’s average realisation at . 62.25 per US dollar in the quarter was nearly 12.7% better than the exchange rate of 55.2 in the year-ago period. This helped it achieve a net realisation price of . 3,257 per barrel of oil, which was 12% higher than the previous year. This aided Oil India in restricting the fall in its profit to just 5.3% year-onyear to . 903.6 crore.
The company is set to gain from the likely hike in gas prices in the next fiscal. However, there is also a possibility of a hike in its subsidy burden. Oil India is being valued at a priceto-earnings ratio of 8.6 with a dividend yield of 6.4%.

Debt, Local Gas Price Hike Loom Over Gail

The 7% drop in Gail’s September quarter net profit was along expected lines. The slowdown in business and likely increase in natural gas prices from April next year remain key concerns for the transporter of thefuel,butthe government appears to be actively considering a move to exempt it from having to participate in the subsidy-sharing mechanism, which will help re-rate the stock despite current woes.
State-run Gail is required to pay a share of the subsidy that the government incurs on selling fuels at below cost.
The company has been trying to cope with the dwindling domestic availability of natural gas, which persisted in the September quarter, with volume dipping to 95.2 mmscmd (million standard cubic metres per day), down 4% from thepreceding quarter and 9.9% lower than in the year earlier.
However, this didn’t impact operating profit as EBIDTA, or earnings before interest, taxes, depreciation and amortisation, grew5% to . 1,463 crore, thanks to take-orpay arrangements with customers. This means that a contracted buyer needs to pick up supplies or pay a penalty.
The company has been investing heavily over the last few years in the expansion of its pipeline network, which has necessitated borrowings. Net debt shot up 47% at the end of September from a year ago, which resulted in a four-fold spurt in interest costs to . 108.2 crore in the quarter. This could prove another drag on earnings, since there may be a lag in capacity utilisation. The other hurdle it faces is the rise in prices of domestically-produced natural gas starting April 2014, which could dent margins in the petrochemicals and LPGbusinesses. It isestimated that the company’s overall costswould goup by around. 1,350-1,400 crore annually on this count. Gail’s subsidy-sharing burden may be limited to what it has paid out so far in the fiscal year — . 1,400 crore. This means earnings may rise in the second half, then slide once gas prices goup in April. Ifthe governmentexemptsthecompany permanently from sharing in the subsidy, Gail could be in for a rerating — not because of any substantial jump in FY15 earnings, but due to reduced uncertainty.

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. 

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.

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.

GUJARAT GAS: A Good Bet for the Long Term

City gas distribution company Gujarat Gas is showing great resilience while going through a challenging phase. Its profits have jumped 47% in the last 12 months despite dwindling volumes. Its cash-rich balance sheet and healthy dividend yield supported by slow but steady growth and attractive valuations augur well for long-term investors. Just like other natural gas utilities in the country, Gujarat Gas too faced pressure due to low availability of natural gas, with its volumes going down 7%, from 1,246 mmscmd in 2011 to 1,157 mmscmd in 2012. In the first half of 2013, volumes dipped further by 15% against a year ago. The company’s dependence on imported liquefied gas, or LNG, too has gone up steadily as domestic production dipped. In 2011, only 37% of the total gas it sold was imported, which rose to 50% in the first six months of 2013. By its very nature, the cost of LNG keeps fluctuating posing another challenge for maintaining profitability. Yet, the company has been successful in passing on its cost increases to final consumers. Its operating profit margin, which was on a downward trend from its high of 24% in year 2010 to 15.5% in 2012, improved to 17.5% for the 12-month period ended June ’13. The company has focused on gaining more customers who would replace liquid fuels — fuel oil, naphtha and the like — with natural gas and thus find even imported natural gas cheaper. Such customers represented only 40% in 2010, which rose to 58% in 2012. The company’s CNG and PNG businesses, which represented 17% of total volumes in 2010, have grown to 25% now thanks to steady conversion of more and more customers. CNG still remains 40% cheaper to petrol, while PNG is around 7-8% cheaper to LPG. The company recently signed an MoU with its parent for long-term supply of 0.85 mmscmd natural gas starting 2014. This will provide visibility to the company’s volume growth in the future. Gujarat Gas will always remain cash rich, as cash generation outstrips its capital expenditure requirements. The company is currently carrying over .560 crore of cash and has over .300 crore of operating cash flows, while its capital expenditure is close to .150-180 crore annually. The natural gas utility is valued at 8.3 times its past 12-month earnings and 2.5 times its net worth, besides offering 3.3% dividend yield, which is attractive for a long-term investor. 

CAIRN INDIA: Rajasthan Work, Re Slide to Benefit Co

Cairn India has emerged as a value creator for investors after the quarter to June results season, in sharp contrast to other petroleum companies whose stocks dropped as much as 11% after they reported their earnings. But for Cairn India, the outlook appears positive. The company’s profit for the Apr-June 2013 quarter was down 18% y-o-y, but the stand-out feature was higher production at akey Rajasthan block during this quarter. The Cairn India stock had lost almost 12% in May and June 2013 after it became clear that production in Rajasthan stagnated during the second half of FY13 raising doubts whether it would drop before rebounding later. Yet, during the Apr-June ’13 quarter, the company was able to marginally raise output in Rajasthan to almost 173,000 barrels per day (bpd) — close to 3% higher than the year-ago period — and scale it up further to 180,000 bpd by the time of the June earnings announcement. The stock has gained 4.3% since reporting earnings for the quarter to June. The company was also able to substantially improve output from its small CB/OS-2 field in Cambay Basin, which had fallen over 18% y-o-y during FY13. The field’s oil production jumped 81% y-o-y to 8,554 barrels per day during the quarter. Similarly, the Apr-Jun ’13 quarter was the first full quarter of natural gas sales of an average rate of 4 million cubic feet daily. Industry analysts are hopeful of more exploration activity in Rajasthan. “Cairn has drilled only 3 exploration and appraisal wells in Rajasthan so far and did not report much news on exploration results. However, it plans to drill 34 E&A wells and targets half of the 530 mmboe risked prospective resources in the year. It has awarded contracts for three more exploration rigs, which are all expected to arrive by the end of the calendar year,” says a report from Jefferies. A weak rupee and the rise in international oil prices are positives for the oil producer. “Cairn’s earnings outlook in the rest of FY14E is much better due to weakening of the rupee and rebound in oil price in the last few weeks. ….We see significant rise in reserves in its main Rajasthan asset as the main share price driver,” a recent Merrill Lynch report said. That should be comforting for long-term investors in Cairn India.

India’s Petroleum Consumption Growth Nosedives

The strong volume growth seen in India’s petroleum consumption over the last two years has slowed. Given that India is the world’s fourth-largest petroleum consumer this should soon start reflecting in global oil consumption growth. However, the problems related to subsidies back home are not easing due to a weak rupee.
Domestic consumption data released by the Petroleum Planning and Analysis Cell shows the growth in consumption of petroleum products, which was 5% in FY12 and 4.9% in FY13, slumped to 1.6% in the April-June 2013 quarter. The data shows that only decontrolled products such as petrol, aviation fuel contributed to volume growth.
“Excluding minor decontrolled products (Petcoke & others representing 11.1% of total in quantity terms), which are insignificant in value terms, the growth in consumption fell 3.1%,” according to the analysis cell.
“There has, no doubt, been a slowdown in domestic petroleum consumption, particularly starting this fiscal,” N Srikumar, executive director, Indian Oil conceded. A number of factors are at play, including overall slowdown in economic activities, according to him.
Diesel consumption grew 6.7% in volumes last fiscal due to a spurt in diesel vehicles, power shortages and even a switch to diesel from industrial fuels on account of its artificially lower prices. Diesel volumes have tapered off from April this year as these factors are no longer in play. Similarly, kerosene consumption volumes are steadily declining as some states are moving towards a ‘No-kerosene’ status and consequently promoting the use of LPG as an alternative. “In Aviation Turbine Fuel, too, the volumes are muted due to the exiting of airlines like Kingfisher and due to route and aircraft rationalisation by airlines,” he says.
Given that India is a large petroleum consumer, a slowdown in domestic consumption is bound to impact global aggregates. “...oil demand growth has been revised down by 11,000 bpd in 2013... due to weaker oil demand from India and Indonesia — driven by a rather lacklustre economic data in India,” said a recent monthly report from OPEC.
India’s growth projections for FY14 is now being revised. In July, the IMF cut India’s growth forecast to 5.6% from 5.8%, while RBI cut its growth forecast to 5.5% from 5.6%. For the April-June 2013 quarter, economic growth is expected to have touched a low of 4.8%. This is bound to impact fuel consumption across the board. “Going forward, unless the economy picks up and overall sentiments improve, petroleum product consumption is not expected to ramp up in a hurry,” says IOC’s Srikumar.

ESSAR OIL Co’s Huge Debt a Key Concern

The huge loss reported by Essar Oil in the quarter to June was on expected lines, as its growing dollarised debt necessitated mark-to-market losses on rupee depreciation. Yet this is a notional loss. However,the key concern is the company’s failure to reduce its debt, partially due to small tranches of capital expenditure that it incurs and sales tax liability installments. Essar Oil’s net loss of . 863 crore was mainly on account of a write-off of . 913 crore towards mark-to-market foreign exchange losses. The operating profitability was also down because of an adverse movement in its raw material prices, which depressed its gross refining margins, or GRM — the differential between revenues from finished products and cost of raw materials or crude oil per barrel. The company posted a GRM of $7.01 per barrel for the June quarter, down from $9.06 in the March quarter and $9.75 in the December 2012 quarter. Refining is a cyclical business. Declining GRMs, therefore, should not be a cause of worry. In fact, there are indications that the GRMs for the July-Sept quarter will be better compared with the June quarter. Essar Oil’s foreign debt, which was at $481 million at the end of March, has risen to $821 million now given the rupee’s depreciation of over 10% in the June quarter. On the flip side, this will mean the company’s inventories will fetch a higher price and the GRMs will translate into higher profits in rupee terms. What will also help is that the company will need to raise $450 million less when it converts its remaining $2.5-billion debt to a dollar-denominated one. The company’s debt of Rs 21,751 crore at the end of March translated into $4 billion then; it is $3.56 billion now. Essar Oil was not able to reduce its debt during the June quarter as it incurred some capital expenditure on refinery and also met its sales tax repayment liability. Its E&P business, particularly the CBM blocks, is in a growth phase and needs significant capital expenditure. The company’s ability to generate more cash over and above these commitments will determine how fast it can reduce its debt burden. Similarly, its ability to achieve full dollarisation of debt will lower its interest burden and extend the overall tenure of its debt, boosting liquidity.

ONGC: Stagnant Output Still a Concern

State-owned oil exploration company ONGC disappointed with its earnings in the June quarter, with a sharp 33% drop in net profit owing to a jump in expenses without any matching growth in revenues. The subsidy burden remained high too, but without much of a change from the figure a year ago. ONGC’s operating costs surged 21% year-on-year while revenues dipped 4.3% to . 19,218.3 crore. The company reported a 78% jump in staff costs, 31% growth in exploration write-offs and 44% increase in other expenses. Overall, the company ended up spending more, but failed to maintain revenues. As a result, operating profits dipped 33% and pre-tax profits slipped 35% to . 2,332.5 crore, as higher depreciation (16.8%) too weighed. The company’s subsidy burden remained above . 12,000 crore for the seventh consecutive quarter — it has been at these levels in nine out of the past ten quarters — but it was just 2.2% higher y-o-y, and hence, was not the primary reason for the disappointing numbers. ONGC’s crude production dipped 0.5% during thequarter to 5.1 million tonnes, while natural gas production was 2.5% lower at 5.77 billion cubic meters. The company has for long been battling stagnation in production, but expects FY14 to show a reversal in trend. But the results are yet to show. When compared with the Jan – March 2013 quarter, its performance was better, thanks mainly to a 67% drop in exploration write-offs. However, the company typically books a large chunk of such expenses in the last quarter of the financial year. After surging to . 340 in mid-May 2013, the ONGC stock has lost over 18%, closing at . 277 before the results were unveiled on Monday. The results for the June 2013 quarter offer little to cheer about, which means that the under-performance of the stock could well continue for a while. 

Rains Can’t Wash Away Fert Cos’ Woes

India may be gearing up for a record agricultural output this year, but domestic fertiliser makers are unhappy. That is reflected in the industry’s gross under-performance on the bourses over the past one year, with most companies having shed between 10% and 60% in value. There may be some improvement in sight, but hardly adequate to make any significant impact on the industry's fortunes.
Sales volumes of the fertiliser industry have been under pressure of late. Provisional data released by the fertiliser ministry shows that total fertiliser sales in the April–June 2013 quarter were down 10.2% compared to year ago. Volumes fell for de-controlled fertilisers, while urea volumes grew 6% to 5.9 million tonne.
“Failure of monsoon last year led to lower sales, which has led to carry forward of higher inventory of finished fertilisers in the current fiscal. This, in turn, would again impact production levels in the current year,” says G Chokkalingam, chief investment officer at Centrum Wealth Management.
Volumes are still down, but a better monsoon is helping companies liquidate their inventory, with urea sales jumping 27% y-o-y in the single month of June 2013. Even non-urea volumes showed a marked improvement in June on a sequential basis. A note from Edelweiss Securities says that non-urea production volumes grew 3.7% y-o-y in June 2013 after 15 straight months of decline, with the only exception of December 2012. 
A recent report from brokerage house Prabhudas Lilladhar also says that their channel checks revealed an improved traction for fertilisers in past one month. The area sown has increased to 518 lakh hectares as compared to 342 lakh hectares at this time last year, the report says. The industry is also battling worsening working capital cycle. “Over . 30,000 crore of subsidy for FY13 was not cleared to the fertiliser companies impacting their balance sheets,” says Centrum’s Chokkalingam. A fall in the rupee over the past two years will also bloat the working capital needs of the industry, according to him. In other words, although the uptick in volumes is a good indication, the sector won’t benefit in the near term.
“We believe short-term challenges persist for the industry due to excessive channel inventory,” says an Edelweiss report. It expects manufactured volumes to pick up, but traded volumes to take a hit. “The underperformance by the sector is likely to continue till the government comes up with strong measures towards mounting subsidy burden on the fertiliser companies,” says Ajit Mishra, assistant vice-president, equity retail research, Religare Securities. Centrum’s Chokkalingam advises investors to stay away from the sector at least in the near term. “Investors can actually wait for June 2013 quarter results, which are expected to turn out poor for many companies,” he says. 

HISTORIC HIGH: Other income rose 33% from a year ago to . 2,535 cr

Other income rose 33% from a year ago to . 2,535 cr 

Other Income Fuels RIL, Capex may Boost Stock 

    It has been close to two years since Reliance Industries, or RIL, reported extra gains from treasury operations to spring a surprise or two while unveiling its quarterly numbers. The company’s results for the quarter to June stood out for the fact that treasury gains were at an all time high, beating analysts forecasts.
RIL’s other income for the quarter soared 33% compared with the yearago period to . 2,535 crore, a historic high. The company said this was mainly on account of profit on sale of investments in fixed income instruments and higher average liquid investments.
Two factors have contributed to this. First, the company was generating more cash than it was investing, resulting in a bulging cash balance, which was . 93,066 crore at the end of June this year. Second, the company was using low-cost foreign currency debt — $12 billion, according to Barclays’ estimates — to fund its capital expenditure plans. This helps it to book interest income on idle funds as income every quarter, when interest expenditure — as well as foreign exchange losses — on borrowed funds get capitalised or added to the cost of assets being constructed.
Reliance, India’s second biggest by market capitalization, had outstanding debt of . 80,307 crore at the end of June this year, up from . 72,427 crore at the end of FY13.
For main business segments such as refining and petrochemicals, the numbers RIL posted for the June quarter were more or less in line with forecast. Gross refining margins, or GRM's, — a measure of the differential between the cost of raw material and revenues from selling finished products — rose to $8.4 per barrel from $7.6 a year ago. For the oil and gas segment, the output drop and its impact on profitability were also in line with analyst forecasts. However, investors need not feel disappointed. The company’s liquidity position will boost capacity expansion. RIL’s capital expenditure programme appears to be gaining pace. During April - June 2013 the company added . 10,523 crore to its fixed assets, which was more than half its net addition in entire FY13. This could gain pace as the stated capacities start getting commissioned, possibly from the second half of FY14. For those with a long-term perspective, these may be good news.