Chennai Petroleum: The Fairest Of Them All

Chennai Petroleum’s current valuations and future prospects make it a promising investment opportunity in the domestic refining sector

PUBLIC SECTOR refinery companies are witnessing a revival in investor interest following a global trend of rising refining margins. During the recent rally, most of these companies touched their 52-week peaks. Among these, standalone refineries look more attractive than integrated companies.
Standalone refiners have petroleum-refining facilities and rely on the integrated players to market and sell their products in the domestic retail market. Integrated refiners such as IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL) have refining, as well as retail marketing channels.
Due to government regulation on retail prices of major petroleum products, integrated refiners suffer from under-recoveries arising out of sales of these products. On the other hand, standalone refiners no longer need to share these under-recoveries with their integrated counterparts and this makes them more attractive in the oil refining sector.
Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery and Petrochemicals (BRPL) are the listed players in the standalone refining space. To help readers find the right pick in this segment, IG did a comparative analysis of the three companies.
MRPL:Located on the western coast, MRPL, an ONGC subsidiary, is the largest among the three with a refining capacity of 12 million tonnes per annum (mtpa). The MRPL scrip has gained nearly 70% in the past one month alone. At the current stock price, MRPL’s enterprise value as a multiple of its operating profit (EV/EBIDTA) is much higher than that of the other two refiners. Also, its refining capacity is valued way higher (m-cap/refining capacity). The refinery is operating at high utilisation rates, recording nearly 106% throughput during the first half of FY08. For future growth, MRPL is expanding its capacity to 15 mtpa by ’10. Given a healthy operating performance and promising future ahead, the MRPL scrip has already run up substantially and the current valuations appear to be on the higher side compared to its peers.
BRPL: BRPL, the smallest in the lot, is IOC’s subsidiary. It has gained over 40% on the bourses during the past one month. At the current price, its stock attracts the lowest P/E compared to the P/Es of other two refineries.
As BRPL operates in the North-East, it enjoys excise duty exemption, which has enabled it to report consistently higher operating margins compared to the others. BRPL’s return on capital employed (RoCE) has also been substantially higher and it enjoys a de-leveraged balance sheet. Considering the last dividend of Rs 3.5 per share, the dividend yield works out to a neat 3.5% — the highest among its peers.
However, BRPL faces problems regarding sourcing crude oil and it has not been able to utilise its capacities fully. Another problem — and a major one — is that, BRPL is set to merge with IOC at an exchange ratio of four IOC shares for every 37 BRPL shares. This limits the upside in the scrip. In fact, at the current price of IOC shares, BRPL shareholders stand to lose around Rs 30 per share.
CPCL: CPCL has so far been a laggard on the bourses, gaining just around 24% during the past one month. Its fundamentals are healthy and its expansion plans will drive future growth. The company’s low equity base means that any profitability growth brings in a more than proportionate jump in its share price.
CPCL’s current valuations appear cheap on various parameters. Both the key valuation multiples — m-cap/net sales and EV/EBIDTA — are at the lower end compared to the other two refineries. Similarly, its refining capacity is valued very cheap.
The company’s performance has been robust historically and it has drawn up plans for future profit growth. Recently, the company commissioned a 17.6-mw capacity wind power project, which is eligible for carbon credits. CPCL is also expanding its refining capacity to 12 mtpa from the current 10.5 mtpa. The company has been continuously investing in improving its energy efficiency, as well as its product mix, which will help it to improve its margins, going forward. Relatively cheap valuations make this company an ideal choice of investment. Investors with a 12-month horizon can consider investing in it.

ARIES AGRO: Small Is Big

Ambitious expansion plans and aggressive marketing strategies are likely to help Aries Agro achieve future growth

COMPANY: ARIES AGRO

ISSUE SIZE: RS 54-58.5 CRORE

PRICE BAND: RS 120-130

DATE: DECEMBER 14-19, ’07

FOUNDED IN 1969 by the Mirchandani family, the Mumbai-based Aries Agro manufactures micronutrients and other nutritional products for plants and animals. The company is raising funds from the primary equity market to fund the five-fold expansion of its production capacities and to strengthen its marketing network. Investors with a 12-month horizon can consider investing in the IPO.

BUSINESS: The company markets a comprehensive portfolio of micronutrients under 41 different brands to nearly seven million farmers through a network of around 6,000 dealers. Micronutrients are elements such as iron, boron, manganese and molybdenum required for the growth of agricultural plants. The company imports certain products such as water-soluble nitrogen, phosphorus and potassium (NPK) fertilisers and markets them in India under its own brand name. It tries to provide maximum customisation in its products to suit the specific geographical and crop needs. Aries Agro has a 21,600 tonnes per annum (tpa) manufacturing capacity at four plants. This is expected to increase to nearly 1,00,000 tpa after it sets up four new plants. The company will also invest in its UAEbased subsidiary, Golden Harvest, to set up another manufacturing plant. It operates in a seasonal industry and clocks over 65% of its annual turnover from July to December, compared to the rest of the year.

GROWTH FACTORS: Aries Agro’s new plants will commence production one by one between February ’08 and September ’08. Domestic demand for micronutrients is currently estimated at 2.5 lakh tonnes, with a growth rate of over 8% per annum. It plans to purchase 100 trucks to market its products, which will improve its geographical footprint. The company focuses on R&D to bring out new products. It has established brands and strong distribution capabilities. The company also has long-term plans to enter the seeds and farm equipment businesses and has established two subsidiaries for the purpose.
FINANCIALS: Its net profit spurted multi-fold to Rs 8.7 crore in FY07 from Rs 1.1 crore in FY05. Sales during this period witnessed a CAGR of 37% to Rs 72.7 crore during FY07. It has demonstrated improved profitability over the years. Operating margin grew from 20.9% in FY06 to 23.1% in FY07. It further rose to 27.2% during the four months ended July ’07. The weakening dollar fares well for the company since it imports nearly 30% of its raw materials.

VALUATIONS: At the higher end of the price band, the P/E works out to 16.8 based on annualised EPS during the four-month period ended July ’07. Aries Agro does not have any direct peer with a comparable business profile. However, it can be broadly classified under specialty chemicals or fertilisers segment. Comparable peers under these categories, such as Ciba Specialty and Rallis India, are currently trading at an EPS of Rs 19.2 and 11.7, respectively. Considering its strong growth prospects, Aries Agro’s valuation appears reasonable. RISKS: The company has reported negative cash flows from operating activities in four of the past five years. Its business is directly linked with Indian agriculture. This exposes the business to the risk of longer credit periods. Thus, the company’s working capital will increase along with its expansion. This may accentuate the problem of negative cash flows.

Chennai Petroleum: The Fairest Of Them All

Chennai Petroleum’s current valuations and future prospects make it a promising investment opportunity in the domestic refining sector

PUBLIC SECTOR refinery companies are witnessing a revival in investor interest following a global trend of rising refining margins. During the recent rally, most of these companies touched their 52-week peaks. Among these, standalone refineries look more attractive than integrated companies.

Standalone refiners have petroleum-refining facilities and rely on the integrated players to market and sell their products in the domestic retail market. Integrated refiners such as IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL) have refining, as well as retail marketing channels.

Due to government regulation on retail prices of major petroleum products, integrated refiners suffer from under-recoveries arising out of sales of these products. On the other hand, standalone refiners no longer need to share these under-recoveries with their integrated counterparts and this makes them more attractive in the oil refining sector.

Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery and Petrochemicals (BRPL) are the listed players in the standalone refining space. To help readers find the right pick in this segment, IG did a comparative analysis of the three companies.
MRPL:Located on the western coast, MRPL, an ONGC subsidiary, is the largest among the three with a refining capacity of 12 million tonnes per annum (mtpa). The MRPL scrip has gained nearly 70% in the past one month alone. At the current stock price, MRPL’s enterprise value as a multiple of its operating profit (EV/EBIDTA) is much higher than that of the other two refiners. Also, its refining capacity is valued way higher (m-cap/refining capacity). The refinery is operating at high utilisation rates, recording nearly 106% throughput during the first half of FY08. For future growth, MRPL is expanding its capacity to 15 mtpa by ’10. Given a healthy operating performance and promising future ahead, the MRPL scrip has already run up substantially and the current valuations appear to be on the higher side compared to its peers.
BRPL: BRPL, the smallest in the lot, is IOC’s subsidiary. It has gained over 40% on the bourses during the past one month. At the current price, its stock attracts the lowest P/E compared to the P/Es of other two refineries.

As BRPL operates in the North-East, it enjoys excise duty exemption, which has enabled it to report consistently higher operating margins compared to the others. BRPL’s return on capital employed (RoCE) has also been substantially higher and it enjoys a de-leveraged balance sheet. Considering the last dividend of Rs 3.5 per share, the dividend yield works out to a neat 3.5% — the highest among its peers.

However, BRPL faces problems regarding sourcing crude oil and it has not been able to utilise its capacities fully. Another problem — and a major one — is that, BRPL is set to merge with IOC at an exchange ratio of four IOC shares for every 37 BRPL shares. This limits the upside in the scrip. In fact, at the current price of IOC shares, BRPL shareholders stand to lose around Rs 30 per share. CPCL: CPCL has so far been a laggard on the bourses, gaining just around 24% during the past one month. Its fundamentals are healthy and its expansion plans will drive future growth. The company’s low equity base means that any profitability growth brings in a more than proportionate jump in its share price.

CPCL’s current valuations appear cheap on various parameters. Both the key valuation multiples — m-cap/net sales and EV/EBIDTA — are at the lower end compared to the other two refineries. Similarly, its refining capacity is valued very cheap.
The company’s performance has been robust historically and it has drawn up plans for future profit growth. Recently, the company commissioned a 17.6-mw capacity wind power project, which is eligible for carbon credits. CPCL is also expanding its refining capacity to 12 mtpa from the current 10.5 mtpa. The company has been continuously investing in improving its energy efficiency, as well as its product mix, which will help it to improve its margins, going forward. Relatively cheap valuations make this company an ideal choice of investment. Investors with a 12-month horizon can consider investing in it.

Interview- MRPL: Eye On The Future

Although refinery margins are on an upswing currently, the risk of a downturn in the long term remains, says LK Gupta, director-finance, MRPL

How is the current gross refining margins (GRMs) situation? Given that several new refinery projects have been launched globally, how will the global benchmark GRMs behave in future?
Mangalore Refinery and Petrochemicals’ GRMs have been fluctuating between $4 and $8 per barrel during the last couple of quarters. We generally track the benchmark Singapore GRMs unless the gasoline cracks are very high, as Singapore refineries produce higher gasoline in their product mix.
Given the current global refining capacity of above 4,000 million tonnes per annum (mtpa), new additions of 200-250 mtpa in the next few years are not expected to have much negative impact on refining margins. Hence, going forward, I think the GRMs are likely to remain high compared to what they used to be in the past.

At what GRM levels will investment in a new refinery be justifiable?
In the past, refineries could work with GRMs at $2-3 per barrel levels. Over the past year or so, the cost of setting up a refinery has gone up substantially with a number of new refinery projects coming up globally. Today, to set up a 15-mtpa refinery, the capital cost will be around $5 billion, taking a conservative estimate. Assuming just 10% return on investment and 5% depreciation, it should generate at least $750 million at the EBIDTA level annually. This translates into refining margins of $6.8 per barrel. Hence, I feel that if in future, the GRMs fall below these levels, no new capacity addition will be feasible. Reliance Industries (RIL) commenced its refinery project just before this spurt in capital costs, which helped it to keep the cost low.

Refining is often termed as a cyclical industry. Currently, where does the global refining industry stand with regard to business cycles?
Currently, we are on an upswing in refinery GRMs. During ’00-03, the global refining industry was going through bad times. No investments were being made in this industry. At times, even the cost of crude oil and processing was not recovered from the selling price of petroleum products. Though the scene has improved in the past three years, the risk of a downturn in the long term remains.

How is MRPL’s capacity utilisation currently? Going forward, what will be the sustainable level of capacity utilisation?
Our nameplate capacity is 9.69 mtpa, but we are operating at around 12.5 mtpa currently. However, in running our refinery at higher capacity, at times, energy efficiency and product slate is not at the most optimal levels. Under the current expansion and upgradation plan, we will increase the sustainable capacity to 15 mtpa by ’10. Then we will benefit not only from higher production, but also from better yields and improved product mix.

What are MRPL’s current capex plans? How does the company plan to expand its refining capacity?
We have planned a capex of around Rs 8,000 crore for our refinery upgradationcum-expansion project, which will be financed through Rs 5,300 crore of debt and Rs 2,700 crore of internal accruals. The project includes an increase in the refining capacity from the existing 9.69 mtpa to 15 mtpa to be completed by ’10. The upgradation will increase the distillate yield by about 10%, eliminating the low-value black oils, and enable processing of higher quantities of cheaper sour and heavy crude oils. Once this upgradation project is completed, MRPL’s refinery complexity and refining margins will be comparable with the best refineries.

What is the current status of your plans to build refineries in Rajasthan and Kakinada?
For the Rajasthan refinery, we have conducted feasibility studies which reveal that without fiscal incentives, it won’t be economically sustainable. If we build this refinery, it will have to be primarily for exports. This is mainly due to the fact that no oil marketing company will buy from us, as their own refineries already exist in nearby states. Discussions with the state government are continuing. As regards the crude oil to be produced by Cairn, we are in discussions with Cairn for finalising the pricing. We understand that a pipeline is being set up to evacuate that crude oil to a western port location by Cairn and ONGC. As of now, MRPL is the government’s nominee for processing this crude. We are also talking to other PSU refineries. A detailed feasibility report (DFR) for a 15-mtpa refinery at Kakinada is being prepared by Engineers India. We will take a decision on implementation after receipt of the DFR.

What are the company’s plans with regard to expanding into the petrochemicals space?
The aromatic complex to produce valueadded products like paraxylene and benzene from surplus naphtha from MRPL is being set up by ONGC Mangalore Petrochemicals (OMPL), a separate special purpose vehicle company of ONGC and MRPL at Mangalore SEZ, with an estimated project cost of Rs 4,852 crore. ONGC will hold 46% of the equity, MRPL will hold 3% of the equity, while the balance 51% will be raised through IPO/strategic investments/product offtake. This project is expected to be completed by December ’10. We are also examining the feasibility of setting up an olefins complex at Mangalore.

How does the depreciating dollar affect your business? What is your take on the rupee-dollar exchange rate over the next two years?
We are a totally dollar-based company, i.e. crude purchases and product sales, both domestic or from/to international markets, are based on the US dollar. Hence, the depreciating dollar affects us mainly to the extent of our GRMs. Due to a depreciating dollar, our margins get impacted adversely when converted into rupees. Going forward, I don’t see the rupee depreciating against the dollar. From the macroeconomic perspective, the country is currently facing a trade deficit mainly due to petroleum imports. However, India’s dependence on import of petroleum products is expected to go down in the long term, given the inclusion of new oil and gas capacities. Gas production by RIL is scheduled to start in ’08, which is equivalent to almost 25 mtpa of crude oil. Similarly, Cairn India/ONGC’s Rajasthan field production of about 7.5 mtpa is likely to start in ’09. India’s exports of petroleum products will also move up significantly due to addition of fresh refining capacity in the next couple of years. A few sectors such as textiles are facing a decline in exports in the current scenario, but this may not pose a major challenge for the strengthening rupee. On the whole, the fundamentals indicate a strong rupee.

The Reserve Bank of India (RBI) has recently allowed domestic refiners to hedge the value of their inventories. How does that help?
RBI has recently come out with guidelines allowing oil companies to hedge their inventories against any substantial fall in prices. The industry operates on $5-7 per barrel margins and if crude oil prices fall suddenly in the global markets, oil companies’ profitability may take a severe hit if they’re stuck with a high-cost inventory. Oil companies can now hedge up to 50% of their average inventory of the previous quarter, which will help them to safeguard the value of their inventories.

RENAISSANCE JEWELLERY: Still Shining Bright

Considering Renaissance Jewellery’s steady growth prospects, investors with a 12-month horizon can remain invested in the scrip

COMPANY: RENAISSANCE JEWELLERY

OFFER PRICE: Rs 150

LISTING PRICE: Rs 190

CURRENT PRICE: Rs 164.55

CURRENT P/E: 10.5

MUMBAI-BASED jewellery manufacturer, Renaissance Jewellery, had issued 53.24 lakh equity shares and 26.6 lakh warrants through an IPO in November ’07 to raise Rs 80 crore. The scrip was listed on the stock exchanges on December 12, ’07 at Rs 190 — a 27% increase over the offer price and closed at Rs 165. The warrants issued by the company were separately listed, which closed at Rs 24.5.
The company plans to use the IPO proceeds to expand its production facilities in SEEPZ and Bhavnagar. The company is also setting up a subsidiary in the US to market its products to medium and smallsized retailers.
Despite the US economy facing risks of a recession, weakening of the dollar and gold prices ruling around historic highs, Renaissance continues with its US-centric approach. Sumit Shah, the company’s managing director, is determined to prevail over these challenges. “The environment is challenging, but we view it as the best time to consolidate our position in the world’s largest consumer country for studded jewellery,” he says. The share of non-US sales, which stood at just 5% last year, are expected to rise above 15% during FY08.
However, the management is taking steps to de-risk the business model. “We have recently entered the bridal jewellery business, the demand for which is relatively inelastic. Similarly, we are also increasing our non-US revenues,” says Mr Shah. The company, which derived around 9% of its sales from bridal jewellery, expects this share to go up to 15% in FY08. The management hopes to maintain over 25% annual profit growth rate for FY08 and FY09.The warrants issued by the company will be convertible at Rs 187.5 into equity shares between April and June ’09. The company expects to collect Rs 50 crore from full exercise of the warrants. According to Mr Shah, “There will be three main avenues for deployment of these funds, viz our retail business in India, the US business and the non-US business. We may float another subsidiary in some non-US markets such as Europe, Middle East or South-East Asia, depending on the growth prospects.”Considering the company’s steady growth prospects, investors with a 12-month horizon are advised to remain invested in the scrip.

Investors in listed PSUs may be in for a windfall

Guidelines state that PSUs having reserves in excess of three times their paid-up capital should consider issuance of bonus shares

IF PUBLIC sector undertakings (PSUs) decide to abide by the guidelines of the department of public enterprises (DPE), then investors in more than half of the listed PSUs could be in for a windfall. DPE guidelines state that PSUs having reserves in excess of three times their paid-up capital should consider issuance of bonus shares. On December 8, ET had reported that the government had instructed IndianOil (IOC) to consider a bonus issue on this parameter. During FY’07, IOC’s reserves were 28 times its paid-up capital. According to a study by ET Intelligence Group, more than half of the actively-traded PSUs meet this requirement.
To put it in perspective, out of the 83 listed PSUs, 52 companies have reported accumulated reserves and surplus that were more than three times their respective paid-up capital during FY’07. This, viewed in the backdrop of the DPE guidelines and the government’s instructions to IOC, may hint at a possibility of bonus announcement by these PSUs.
The list includes PSUs from various sectors including banking, petroleum production and refining, metals and engineering. On the top of the list is the lignite producer Gujarat Mineral Development Corporation. The reserves of this Rs 600 crore mining company were 126 times more than its paid-up capital by the end of FY’07. It is followed by Tide Water Oil Company, a Rs 421-crore oil and greases manufacturer and State Bank of India, the largest bank in the country, which had earned over Rs 39,000 crore in interest income during FY’07.
It needs to be noted that DPE has issued only a guideline. “The DPE guideline need to be looked more as a directive than a mandatory rule. What the guideline means is that on a face value of Rs 10, the PSUs having book value of more than Rs 40 per share may consider giving a bonus issue,” says SP Tulsian, an investment advisor. This means PSUs may still observe their discretion while taking a decision in this regard.
Another point to be noted is that a bonus issue may not be advisable for companies which have been witnessing a decline in their net profits or those companies where earnings visibility is low. In such cases, a bonus issue may reduce the dividend per share paid by the company. This is particularly relevant for oil marketing companies (OMCs). Profits of OMCs are reeling under the burden of fuel subsidies. “Currently there is no certainty about future profitability of oil companies. Unless the situation improves and gives us some confidence of servicing the increased equity capital, it will be imprudent to consider any bonus issue,” says SK Joshi, finance director, BPCL.
Experts think that the directive would not serve much purpose as it mainly results into a mere adjustment in the books of account of the companies. Mr Tulsian says, “A bonus issue would increase the paid-up capital by reducing the reserves of a company. This means there is no change in the net worth of the company. Further, such a decision would not increase the free floating shares of the company in the market.” Free float for some of the PSUs including NMDC, National Fertiliser and RCF is below 10% of the total number of paid-up shares as the government holding in these companies is very high. Some of these stocks have seen a huge jump in prices on the bourses in recent times. Mr Tulsian thinks that splitting the number of shares would lead to improved free float of the shares of such companies instead of giving bonus shares and may curtail speculative movements in share prices

SEAMEC: Docked vessels may take a toll on Seamec topline - 12th December 2007

SEAMEC, which provides offshore support to petroleum exploration and production companies, is likely to see a dip in its performance during the December 2007 quarter. The Rs 200-crore company has been unable to deploy two of its vessels during the current quarter, leading to substantial loss of revenue. The vessels, which are currently in shipyards undergoing repairs and upgradation work, have faced delays in work completion.

Seamec currently owns and operates three multisupport vessels (MSVs) required in the offshore petroleum production industry and had acquired a fourth vessel in mid-2006 to ramp up its fleet. The charter rates for MSVs have moved up substantially over the past couple of years, in line with the industry trends, to around $50,000 per day currently.
Seamec’s fourth vessel, Seamec Princess, scheduled to commence business by June 2007, has already spent six extra months in shipyard for upgradation and is still to commence business. One of its working MSVs — Seamec II — while undergoing periodic dry-docking in September 2007, suffered an accident, thus putting it out of business for the entire quarter.
With both these vessels spending their time in the docks, the company could operate only two of its vessels during the current quarter. The company, which follows December year-end, is likely to report a fall in its quarterly revenue on a y-o-y basis. Since the company is also likely to book the dry-docking expenses in the current quarter itself, its profitability also would take a hit. However, the future does appear bright for the company, which expects to engage all four of its MSVs throughout 2008 resulting in higher revenues and improved profits. During the past one year, Seamec’s shares have moved up from Rs 155 level to cross Rs 255 in July 2007. However, the scrip has witnessed a decline since then. It has remained range-bound around Rs 200-220. The company, which appears to tread cautiously with regard to investing in the business despite the booming offshore industry, commands the lowest P/E among its peers.

Tata Chemicals: Just The Right Chemistry

Tata Chemicals is not only expanding its core businesses, but is also diversifying into new areas. The stock is an excellent investment target for investors with a 12-month horizon

TATA CHEMICALS (TCL), one of the world’s largest manufacturers of soda ash, is benefitting from rising soda ash prices globally, while policy changes have boosted the profitability of its fertiliser business. It has embarked upon several capacity expansion projects and is diversifying into biofuels. TCL will reach new heights once these projects come on-stream in FY09. Consider investing in the company with a 12-month horizon.
Incorporated in 1939, TCL is India’s leading manufacturer of inorganic chemicals, fertilisers and food additives. The company, which is currently valued at a little over Rs 8,000 crore, reported consolidated net sales of Rs 5,800 crore for FY07. TCL acquired UK-based soda ash maker Brunner Mond in December ’05, which owns plants in the UK, the Netherlands and Kenya. It also holds one-third equity stake in a phosphoric acid manufacturing Moroccan company IMACID.

BUSINESS: TCL’s fertiliser manufacturing business contributes nearly 60% to its total revenues. It has a 0.87 million tonne per annum (mtpa) capacity of urea and 1.2 mtpa capacity of phosphatic fertilisers. TCL is also one of the world’s leading synthetic soda ash makers with a total combined capacity in excess of 3 mtpa and commands an 8% global market share. It has 50% share in the branded, iodised salt market in India. It is also aggressively optimising costs in a bid to sustain the competitive advantage in global markets.

GROWTH DRIVERS: Currently, TCL has gained, thanks to two favourable developments. The first of these is policyrelated: the quarterly system of calculating subsidy is now done on a monthly basis, and subsidy towards distribution cost has increased. This has resulted in higher and quicker receipts of subsidy payments from the government. TCL will also benefit from any further easing of the government’s fertiliser policy. The second factor is the global shortage of soda ash, which has boosted prices to new highs. Hence, soda ash prices, at $300 per tonne, are around 40% higher on a year-on-year (YoY) basis.
TCL also has aggressive growth plans. Debottlenecking projects are under way at its urea as well as inorganic chemicals plants, which will be completed by September ’08. This will boost TCL’s domestic soda ash capacity by 30% and urea capacity by 60%. Even the cement and salt capacities will go up. These additional capacities, when fully functional, will add over Rs 1,100 crore in revenues annually.
Besides India, TCL aims to expand its presence in the global soda ash business as well. It recently expanded its soda ash capacity in Kenya, which is one of the lowest cost producers of soda ash in the world. The company plans to set up another plant there. Besides its existing business, TCL is also diversifying into new areas. Biofuels is one such business it is bullish on.
The company is setting up a 30-kilolitres-per-day (klpd) sweet sorghum-based ethanol facility at Nanded in Maharasthra. This facility is being set up as a prototype, which, if works well, can be expanded to 100 klpd in future. It has also formed a company called ‘Khet-Se Agriproduce India’, in a 50:50 joint venture with Total Produce of Ireland, to foray into wholesaling agricultural commodities — one of the fast-growing business opportunities in India.

FINANCIALS: TCL reported a healthy 26.1% growth in net profit in H1 FY08 on a consolidated basis, despite a mere 2% sales growth. It also expanded its operating margins, thanks to stringent cost management. The performance would have been even better, had it not been for exceptionally heavy rains in Gujarat, which affected the production at its plants. TCL posted 18.6% YoY growth in net profit and 43.9% YoY growth in sales for the year ended March ’07.

VALUATIONS: At the current market price of Rs 360, the scrip is trading at around 13.8 times its consolidated EPS for trailing 12 months at Rs 26.1. Based on the estimated forward EPS of Rs 35.2 for FY09, the P/E will be 10.2. This is highly attractive, considering TCL’s current performance, as well as expansion plans. Being a Tata group company, TCL holds equity stakes in most of the group companies such as Tata Motors, Rallis India, TCS, Tata Tea and Tata Steel, among others. The current market value of these listed investments accounts for roughly one-fifth of TCL’s total market capitalisation. Considering all these aspects, we believe TCL is an excellent investment target for investors with a 12-month horizon.

RISKS: The newly expanded soda ash capacity in Kenya is currently facing some technical problems and is running only at 30-40% capacity. Full benefits of this facility may not be available till the end of FY08. Any significant fall in global soda ash prices may have a negative impact on the company’s growth.

POTENT MIX
TCL is present in all three key agro-nutrient segments in the fertiliser business — nitrogen (N), phosphorous (P) and potassium (K) Easing of government’s fertiliser subsidy payment policy has had a positive effect on TCL’s cash flows It is diversifying into the biofuel business and wholesaling of agro-products Debottlenecking projects will add around Rs 1,100 crore to sales on completion TCL has set up an innovation centre at Pune to explore new business areas in nano and biotech space TCL operates ‘Tata Kisan Sansar’ network of 514 outlets in North and East India to provide agri-inputs to farmers TCL’s ‘Khet-Se’ initiative involves setting up collection and processing centres, as well as a cold chain for the distribution of fresh vegetables and fruits Tata Salt controls over 50% market share in the branded salt segment in India TCL’s production at the Mithapur plant was affected during the quarter ended September ’07 due to heavy rains and technical problems

BGR Energy Systems: Power Struck

BGR Energy’s valuations are stretched based on past performance. But its high growth prospects make it attractive for the long term

COMPANY: BGR ENERGY SYSTEMS
ISSUE SIZE: RS 388.3-438.5 CRORE
PRICE BAND: RS 425-480
DATE: DECEMBER 5-12, ’07

CHENNAI-BASED BGR Energy Systems is coming out with an IPO comprising 4.32 million new equity shares and 4.82 million equity shares of its promoters. Post-issue, shareholding of promoters will fall to 81.3%. It plans to raise Rs 207 crore from the IPO and Rs 138 crore from pre-IPO placements, at the upper price band, to fund its long-term working capital needs of Rs 125 crore and expansion plans of Rs 80 crore. It will set up manufacturing facilities in India, China and Bahrain over the next 12 months. Investors with a 12-month horizon can invest in the IPO.

BUSINESS:
BGR supplies systems and equipment to process industries and undertakes turnkey engineering projects in power, environmental engineering and infrastructure sectors. In power generation projects, it undertakes turnkey projects to supply balance of plant (BOP) or all items other than boiler, turbine and generator. It has executed 131 projects so far in 42 countries and has an order book of over Rs 3,300 crore, 75% of which is contributed by power projects, with the oil & gas industry representing 13%.

GROWTH STRATEGY:
The company is well placed to benefit from the spurt in domestic power generation industry, which may invest Rs 3 lakh crore in the next five years to add over 65,000 mw of capacity. From BOP contracts, it’s moving up the value chain to obtain main engineering, procurement and construction (EPC) contracts. Overseas manufacturing facilities and Mundra SEZ will help reduce delivery time and improve cost efficiencies.

FINANCIALS:
BGR’s financials are not comparable with its past performance due to a change in its financial year and also because it sold a part of its business in June ’07. A comparison of the performance for the 18-month period ended March ’07 against comparable adjusted figures for the year ended September ’05, shows that sales have risen 77% to Rs 786.8 crore. With improving operating margins, net profit is up 97% at around Rs 40 crore.

VALUATIONS:
Given the post-listing equity of Rs 72 crore, it demands a P/E of 49.4 at the higher price band. This is on an annualised EPS of Rs 9.7 for the June ’07 quarter. Based on annualised EPS for the 18-month period ended March ’07, P/E stands at 129.7 at the higher price band. The group of comparable listed companies from engineering/capital goods space trades at an average P/E of 61.4 based on EPS of trailing 12 months. IPO valuations are stretched based on past performance. But considering high growth potential, long-term investors can subscribe to it.

RISKS:
BGR’s move to become the main EPC contractor for power projects will put it in direct competition with players which have hitherto been its clients. Moreover, the ban imposed on it by Bhel for three years may adversely impact its business in future.

Rel Petro investors should look at rollovers for cues

FOLLOWING the steep fall in the share price of Reliance Petroleum, what should retail investors do? The surge in the stock last month had many retail investors flocking to the counter, even as experts were crying hoarse that the shares were overvalued. After touching a peak of Rs 295 earlier this month, the stock price has been hurtling downhill.
The stock is yet to emerge out of the trading ban in the derivatives segment — it had done so for brief while on Monday — players expect some more volatility at the counter.
Investors should continue to tread cautiously, warn market watchers. “The current confusion regarding the stock’s movement would get cleared by the expiry of derivatives on Thursday and by then RPL is expected to come out of F&O curb,” said PINC Research headderivatives and strategy Sailav Kaji.

“What is needed to be looked at is whether in the derivatives expiry short positions are rolled over or get covered. In case of short positions getting rolled over, the stock will find support at Rs 180,” he said, adding that long-term investors can still buy the stock at current levels.

Sentiment has been undermined by the promoter, Reliance Industries’, decision to offload 4% stake in Reliance Petroleum through open market trades.

Market watchers said the next key trigger for the stock will be Chevron’s decision on its 5% stake in Reliance Petroleum. Chevron has an option to raise its stake to 29%, but analysts see a low possibility of that happening following RIL’s decision to sell shares in the open market.

”We believe that RPL’s rich valuation and the fact that RIL sold a 4% stake to the market, may imply a possible future Chevron exit unless there is meaningful pullback in the market,” broking house Goldman Sachs said in a note to clients.

Many analysts expect RPL to stabilise around Rs 180 near term. However, Religare Securities president-equities Amitabh Chakraborty said the stock could rally to Rs 215-220 by the end of the December derivative series.“Investors who are right now long on RPL futures should roll over their positions to the December series,” he said. The 29-million-tonne-per-annum refinery being built by Reliance Petroleum was originally scheduled to commission by December 2008. However, considering the fact that almost 70% overall progress has already been achieved, the management expects to complete the project ahead of schedule. By crunching the original timeline of three years, the company is poised to create a new world record for project implementation in the refining sector.

HPCL:For A Refined Taste

With the valuations of private sector petroleum companies soaring in the current rally, PSU oil stocks appear value buys. HPCL seems to be the most undervalued of the three PSU oil marketing companies

DESPITE THE strong rally on the bourses, one group of companies has strictly remained non-participative — the public sector oil marketing companies (OMCs) IndianOil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL). Thanks to cheaper valuations, we believe an investment opportunity exists in this sector. Comparing these three companies on various parameters, HPCL appears to be the most undervalued. It is trading at around its book value and offers over 6% dividend yield at current price. Those looking for a value buy and dividend yield can consider investing in this scrip. HPCL is an integrated refining and marketing company operating two refineries (Mumbai and Visakhapatnam) with a total capacity of 16.2 million tonnes per annum (mtpa). It ranks below IOC and BPCL in retail market share, which is around 17%. HPCL, in a joint venture with Mittal Energy, is setting up a 9-mtpa refinery at Bhatinda in Punjab by ’10. Currently, HPCL sells four petroleum products — petrol, diesel, LPG for domestic consumption and kerosene through the public distribution system — at administered prices determined by the government, which leads to under-recoveries. The government shares a part of these under-recoveries by way of oil bonds, while public sector upstream companies such as ONGC and Gail share a part of the burden through discounts offered to OMCs.

BUSINESS:
HPCL owns or operates 8,000 retail outlets across the country, selling auto fuels, out of which over 3,500 supported with non-fuel offerings are branded ‘Club HP’. For rural India, HPCL has launched the ‘Hamara Pump’ format, wherein farm inputs such as seeds, pesticides and fertilisers are sold along with fuel. It also caters to the LPG requirements of over 25 million households. HPCL is one of the leading players in the domestic lubricants market and is also expanding its aviation turbine fuel (ATF) business. It has floated a number of JVs in the energy value chain to diversify risks and augment its cash flows. Prize Petroleum, in which HPCL holds a 50% stake, is into petroleum exploration and production. It has signed a service contract for an offshore field cluster comprising three oilfields and has also been awarded an onshore block under NELP VI. These initiatives are expected to aid future growth.
Bhagyanagar Gas has commenced CNG operations in Vijayavada and Hyderabad. Similarly, Aavantika Gas is in process of launching CNG operations in Indore, with plans to extend to other major cities in Madhya Pradesh. HPCL holds 22.5% stake in each of these JVs. HPCL has also established JVs for bitumen products, LPG storage and pipelines. It is investing in alternate energy sources and has entered into contract farming for cultivation of Jatropha in Chhattisgarh. It has set up a 10-mw windmill electricity generation capacity, which will be expanded to 100 mw in a phased manner.

VALUE DRIVERS:
HPCL is progressing well in its core business of refining and marketing of petroleum products and has lined up several projects. Its major projects include lube oil base stock upgradation at Mumbai refinery, upgradation for production of Euro IV-compliant fuels, facilities for mixed xylene and propylene production at Mumbai and Vizag refineries and delayed coker unit for bottoms upgradation at Visakhapatnam. These projects will improve product quality, resulting in better margins. It is also planning to develop a special economic zone (SEZ) near its Vizag refinery by setting up a petrochemical and petroleum investment region to produce petrochemicals and other high-value products.

FINANCIALS:
HPCL’s crude throughput witnessed a compounded annual growth rate (CAGR) of 6.6% over the past five years, thanks to capacity expansion and utilisation. This helped HPCL to produce 77% of the petroleum products that it sold during FY07, compared to 68% during FY03, thereby reducing dependence on traded goods. For H1 ended September ’07, sales grew 4% to Rs 43,761 crore, but the value of special oil bonds received from the government came down by 19% to Rs 2,356 crore. Its operating profit margins remained unchanged at last year’s level. A 155% jump in other income helped it register 25% PAT growth at Rs 766 crore.

VALUATIONS:
HPCL appears undervalued compared to its peers, IOC and BPCL, on three main counts. Firstly, HPCL’s price to book value ratio (P/BV) is the lowest at just 1.01. Secondly, its market capitalisation (m-cap) to refining capacity ratio is also the lowest at Rs 5,914 per tpa. And most importantly, its dividend yield is over 6.2%, which is substantially higher than that of its peers. At the same time, nearly onethird of its m-cap is represented by value of its quoted investments, which again, indicates its undervaluation. While high crude oil prices in the international market and excessive dependence on government policies remain the key risks, a softening of prices or the government’s decision to hike domestic fuel prices will lead to a dramatic improvement in HPCL’s finances and may trigger a sharp rise in its stock price.

SLICK MOVES
HPCL operates two refineries at Mumbai and Visakhapatnam with a total capacity of 16.2 mtpa
The company ranks below IOC and BPCL in retail market share, which stands at around 17%
HPCL has a highly attractive dividend yield of over 6.2%
One-third of its m-cap is represented by quoted investments
Its crude throughput has witnessed a 6.6% CAGR over the past five years
HPCL, in a JV with Mittal Energy, will set up a 9-mtpa refinery at Bhatinda by ’10
It also proposes to develop an SEZ near its Vizag refinery by setting up a petrochemical and petroleum investment region
HPCL is investing in alternate energy sources and has entered into contract farming for cultivation of Jatropha Upgradation projects are set to improve product quality, resulting in better margins

Q2 show belies fertiliser cos’run up on bourses

MOST fertiliser stocks are on a dream run on the bourses over the past one month, appreciating up to 50% during the period and 120% in case of National Fertilisers. This euphoria is mainly driven by expectations about a better future.
However, the optimism is not reflected in the September quarter results of these companies. If at the aggregate level the figures appear unattractive, that is mainly due to the two loss-making heavyweights — Southern Petrochemicals Industries (SPIC) and Fertilisers and Chemicals Travancore (FACT). Most of the other companies have reported healthy performances by improving upon their past.
The group of 21 listed fertiliser posted an aggregate net sales growth of just 6.4% during the quarter to Rs 11,248 crore. Operating margins improved marginally, thanks to reduction in raw materials, power and fuel expenditure while staff and other costs increased.
The loss-making fertiliser manufacturers, SPIC and FACT, witnessed significant fall in sales. Another important company to post a fall in net sales was Chambal Fertilisers. In contrast, GNFC, RCF, Godavari Fertilisers and Coromandel Fertilisers outperformed their peers in sales growth.
Gains on fluctuations in foreign exchange helped the industry report a 39% rise in other income. The resultant PBDIT was 12.7% higher, which translated into 17.3% growth at PBT level on account of slower growth in interest and depreciation. The bottomline growth at the aggregate level was a slower 13.6% at Rs 565 crore, as the tax provisions rose more than proportionately.
GNFC, National Fertilisers, Chambal Fertilisers and Godavari Fertilisers were the star performers during the quarter with PAT growth exceeding 45% on y-o-y basis. Smaller companies such as Asian Fertilisers, Liberty Phosphates and Shiva Fertilisers also put up an impressive show. On the other hand, the performance of companies such as Nagarjuna Fertilisers and RCF was disappointing with fall in profits. SPIC, FACT, Bharat Fertilisers and Rama Phosphates continued to incur net losses.
In the past, a number of fertiliser companies used to derive profit growth mainly from their non-fertiliser businesses. However, during September quarter, Tata Chemicals and GNFC — fertiliser firms which have strong presence in non-fertiliser chemicals — saw the fertiliser division outperforming that of chemicals.
FACT’s disastrous performance too, was on account of heavy losses in its petrochemicals business, while its fertiliser business partially curtailed losses during the quarter. On the contrary, the performance of Deepak Fertilisers improved only because it cut down on its fertiliser business.
The industry is waiting for a new lease of life once the supply of natural gas improves. The government has mandated urea manufacturing units based on fuel oil or naphtha to convert to natural gas by 2010 under the third stage of the new pricing scheme for urea. Considering the ever-rising subsidy burden along with the pending subsidies of earlier years, the government has decided to issue fertiliser subsidy bonds worth Rs 7,500 crore.

Oil field services in for good times

Soaring Crude Prices And Conducive Exploration, Production Scenario Boost Sector

AFTER languishing for over two decades, oil field services sector is getting ready for a high tide. The upturn has been largely due to an increase in crude oil prices and a likely move by the government to come out with the seventh round of New Exploration Licensing Policy (NELP), say analysts. The stock prices of most of the companies in the sector have seen a huge appreciation in the past month alone, outperforming the broader indices with a substantial margin in most cases.

Analysts further point out that the offshore support industry is witnessing strong demand due to the conducive global scenario for sustained exploration and production capex. The global petroleum explorations and production (E&P) majors are witnessing high earnings over the hurdle rates internally fixed by the companies. This has helped to sustain the capex. They add that the global offshore rig market is at its strongest point in the past decade and many companies in the sector continue to pose strong fundamentals and high earnings visibility with attractive valuations.

Even if the crude oil prices fall, the demand for offshore supply vessels (OSV) will not go down substantially. They cite various reasons like the global oil scenario, increase in offshore activities and supply factor. “Globally, oil majors are cash rich as the price of crude is high at this time. They are investing heavily in exploration. Further, exploration is moving from onshore to offshore. With the increase in offshore activities, demand for rigs has gone up.”

“Few years back the demand for OSVs was low, and thus supply remained stagnant. Now, the demand has outstripped supply. This has led to a spurt in the prices of even the second hand vessels,” says Chirag Dhaifule of Emkay Share and Stock Brokers. Further, they point out that the emerging Rs 8,000 crore seismic services market in India is driven by a combination of rising oil demand, under-penetrated oil geography and a bullish oil market. This is leading to a substantial growth in not only new exploration projects but the revival of abandoned fields. “About 50% of this business opportunity will be addressed by in house crews of ONGC and Oil India, the remaining business will be executed by merchant third party service providers like Asian Oilfields and Alphageo,” says Sushil Finance equity analyst Kapil Bagaria.
The stock prices of Asian Oilfield, Alphageo and Dolphin Offshore have given returns of about 50% in the past one month alone. The expansion projects of the companies are paying off — Aban Offshore acquired a Norwegian company previous year, its stock has appreciated about 35% in one month. Garware Offshore, which saw 20% appreciation, added some vessels recently. Great Offshore has added four vessels to its fleet in the past 12 months. Similarly, Seamec had acquired a fourth vessel last year, which is now set to commence commercial operations soon. Recently, Asian Oilfield received an order from Oil India worth Rs 72 crore.

ZUARI INDUSTRIES: On Fertile Ground

Zuari Industries’ business is worth Rs 2,750 crore, which is substantially higher than its current m-cap. It’s an ideal stock for those who prefer value investing

ZUARI INDUSTRIES (ZIL), the flagship company of KK Birla group appears grossly undervalued at its current market price. Besides being one of India’s leading fertiliser makers on a standalone basis, the company is also a promoter of Chambal Fertilisers and indirectly holds over 40% stake in Paradeep Phosphates, the country’s secondlargest manufacturer of phosphatic fertilisers. Besides, it has over half a dozen subsidiaries and joint ventures (JVs), most of which are doing well.

However, ZIL’s current market capitalisation (m-cap) doesn’t reflect the embedded value of these other assets. Considering the value of its investments and land bank, we estimate the embedded value of this company to be Rs 2,750 crore, against its current m-cap of just around Rs 930 crore. This makes ZIL an ideal stock for those who prefer value investing. BUSINESS:ZIL currently produces over 1.15 million tonnes per annum of nitrogenous, phosphatic and complex fertilisers at its plants in Goa. Besides these, the company trades in MOP, agrochemicals, biofertilisers and other specialty fertilisers. It has also set up a number of subsidiaries and JVs around its core business. The company currently uses naphtha at its urea plant and plans to convert this to natural gas feedstock by ’09 as per government policy. ZIL is currently in talks with Gail, which may extend its natural gas pipeline from Dabhol to Zuari’s fertiliser plants in Goa.

GROWTH DRIVERS:
Although subject to subsidies, the company’s core business of fertilisers is now profitable and growing steadily. The future outlook of the fertiliser industry seems encouraging. With rising domestic demand for fertilisers, the government has to allow more concessions to the industry, so as to encourage investments and capacity expansions.
The three group companies — Chambal Fertilisers, Paradeep Phosphate and ZIL — have a combined fertiliser production capacity of around four million tonnes. This makes the Zuari group India’s largest fertiliser group with three strategically located plants in west, east and central India. It also gives the Zuari group access to almost 80% of India’s cultivable area and puts it in an advantageous position compared to its peers.

FINANCIALS:The company was making losses till ’04-05 and has turned around subsequently. During FY06, it posted a net profit of Rs 44.4 crore on a consolidated basis, which jumped to Rs 420.9 crore in FY07. This included an extraordinary gain of Rs 350 crore on sale of its stake in its cement JV. The company registered a minor 8.5% growth in net profit to Rs 44 crore during the first half of FY08 against the corresponding period last year, excluding the impact of extraordinary income. Sales during this period fell 4% to Rs 1,235 crore.

VALUATIONS: The company’s core business generated net sales of around Rs 2,400 crore in FY07 and PAT of Rs 90 crore. At the industry P/E of 12, this should be valued at around Rs 1,000 crore, which in itself, is higher than its current mcap. Apart from its core business, ZIL also has a number of investments in subsidiaries and JVs, which are coming of age. The company has two wholly-owned subsidiaries, Indian Furniture Products and Simon India, while it owns 93.5% stake in Zuari Seeds. All these companies have established set-ups and have turned around. Zuari’s stake in all these subsidiaries is worth around Rs 100 crore.
The company also has three JVs — Zuari Maroc Phosphate (50% stake) that owns over 80% in Paradeep Phosphates, Zuari India Oiltanking (50% stake) and Zuari Investments (50% stake). Paradeep Phosphates posted a net profit of Rs 110 crore in FY07. At the industry P/E of 12, this company can be valued at Rs 1,320 crore. ZIL also has investments in some listed companies, such as Chambal Fertilisers (12.9% equity stake). The current market value of these quoted investments is around Rs 350 crore.
Moreover, the company owns land bank in excess of 50 acres in Goa, where it is planning to set up an IT special economic zone (SEZ). The value of this land bank is estimated at around Rs 700 crore. All these put together, ZIL’s current business is actually worth Rs 2,750 crore, which is substantially higher than its current m-cap. This provides an excellent opportunity for long-term investors to benefit from valueunlocking over a period of time.

Dazzling Delight

Renaissance Jewellery’s IPO is fairly priced,with detachable share warrant being an additional sweetener.Investors with a 12-month horizon can subscribe to it

COMPANY: RENAISSANCE JEWELLERY

ISSUE SIZE: Rs 66.6-79.9 CRORE

PRICE BAND: Rs 125-150

DATE: NOVEMBER 19-21, ’07

MUMBAI-BASED Renaissance Jewellery is coming out with an IPO of 5.3 million equity shares of Rs 10 each. The company will also issue one detachable share warrant for every two equity shares allotted, convertible into equity shares after 16 months of the allotment at 125% of the issue price. Postissue, the promoters’ shareholding will come down to 71%, which will further fall to 62%, assuming full exercise of warrants. The company intends to raise around Rs 80 crore (at the upper price band) to fund its expansion plans. It plans to expand its manufacturing units in Mumbai and Bhavnagar and set up a subsidiary in the US to expand its marketing activities. Investors with a 12-month horizon can consider subscribing to the issue.

BUSINESS:

Renaissance Jewellery is a decade-old company promoted by Niranjan Shah. It manufactures studded gold, platinum and silver jewellery primarily for the US market.
The company has three manufacturing units — two in Santacruz Electronic Export Promotion Zone (SEEPZ) in Mumbai and a 100% export-oriented unit (EOU) in Bhavnagar — to cater to the exports market. Besides, its two wholly owned subsidiaries — Verigold Fine Jewellery and Renaissance Retail Ventures — have manufacturing facilities at SEEPZ and Andheri, respectively. The units in SEEPZ and the EOU enjoy income tax exemption till FY09.
The company boasts of a 40-member team of skilled designers, who are able to develop a large number of designs in line with the current fashion trends. In the domestic market, the company has set up around eight retail outlets through its subsidiary and sells jewellery products under the brand ‘Lucera’, which is being positioned as an affordable fashion accessory.

GROWTH STRATEGY:

The company has recently forayed into new product categories such as bridal and solitaire jewellery, which are high-margin categories compared to fashion jewellery. It has decided to increase its market reach by targeting medium and small-sized retailers and is setting up a subsidiary in the US. A portion of the IPO funds will be utilised to expand its manufacturing capacities. The company also plans to expand its presence in other overseas markets such as the Middle East and Far East. It even intends to expand its domestic retail business through its subsidiary.

FINANCIALS:

The company’s sales have witnessed a compounded annual growth rate (CAGR) of 37.6% from FY03 to reach Rs 438.5 crore in FY07, while PAT saw a 61.7% CAGR to stand at Rs 25.4 crore in FY07. During the quarter ended June ’07, the company posted a net profit of Rs 7.2 crore on total income of Rs 122.8 crore. Its PAT margins have risen consistently during this period to reach 6.1% in the June ’07 quarter. During the latest quarter, the company derived nearly 96.7% of its revenues from the US. Sales from the domestic market contributed a mere 0.4% to its revenue, while exports to rest of the world stood at 2.9%.

VALUATIONS:

At the lower price band of Rs 125 per share, the P/E multiple works out to 7.9, considering annualised EPS of Rs 15.7 for the quarter ended June ’07 on post-IPO equity. P/E at the higher price band of Rs 150 is 9.5. The group of comparable listed companies is currently trading at an average P/E of 18.3. Comparatively, the IPO appears fairly priced, with the warrants being an additional sweetener. RISK FACTORS: Renaissance Jewellery is highly dependent on a small group of large customers in the US for its sales. The company wants to diversify its risk by reaching out to smaller players, but it has not conducted any market survey for its feasibility. Recently, global gold prices have shot up above $800/troy ounce.
Jewellery imports into the US used to enjoy preferential treatment earlier, but since July ’07, an import duty of 5% has been imposed on them. These factors are likely to affect demand for the company’s products negatively over a period of time. Moreover, depreciation in the US dollar may affect the company’s operating margins, going forward.

Subsidy fossil turns fuel for promoting inefficient economy

THE government decision to stick to the easy solution of subsidising petroleum products to shield people from rising international crude oil prices has caused a perverse situation. While it has destroyed the wealth of shareholders of oil marketing companies (OMC), huge liabilities have been created for future. The oil bonds, which the government has issued and is planning to issue for 2007-08, will create a huge burden of over Rs 60,000 crore to be repaid in future. That’s not all. A policy of cheap oil means less incentive for consumers and industry to conserve energy.
Reeling under mounting losses, the OMCs have turned out to be losers on bourses, when other companies created enormous wealth for their shareholders. By October 2007, the Sensex had gained around 45% during previous 12 months and private oil major Reliance Industries had more than doubled its market capitalisation. In contrast, government-owned OMCs witnessed a fall in their market capitalisation. During the October 2006-October 2007 period Indian Oil’s market capitalisation fell 5.3%, BPCL’s by 16.8% and that of HPCL by 28.4%. However, the situation has marginally improved as IOC’s market capitalisation rose in last two weeks.
It is the government, which has emerged the biggest loser being the largest shareholder in these OMCs while the situation of the retail investors in these companies continues to remain miserable.
And who is responsible for this value destruction? Of course the subsidies of fuels by the government. The government feels it necessary to offer petrol and diesel at lower rates for retail consumption to shield Indian consumers from inflationary pressure of higher oil prices. But there was a better way to achieve this, lower the burden on indirect taxes, Custom duty, excise and sales tax, imposed on these products.
Besides the heavy spurt in international crude oil prices, huge indirect taxes imposed by central, state and local governments are all the same responsible for the over-inflated retail prices of petrol and diesel in India. Indian retail prices of petrol and diesel typically comprise of around 55% of taxes i.e. out of Rs 50 per litre of petrol that a consumer pays around Rs 27.50 goes in form of various taxes.
High level of indirect taxes in itself is not an evil and India consumers are certainly not the highest taxed citizens in this regard. European countries historically have even higher indirect taxes on these transport fuels, which has helped the governments to raise resources while inducing energy conservation. Despite the high level of economic growth, the consumption of petroleum products in the Europe has grown at a CAGR of 1.3% over last 15 years - substantially lower compared to 1.9% in the US, which favours cheap oil policy.
However, the current situation in India is comic where both - high taxes and subsidies - co-exist. While the political leadership wants to offer the fuels at subsidised rates, it is not ready to cut down on its handsome tax income. Oil sector contributes over one-third of Indian government’s gross tax revenues. The issue of oil bonds to the OMCs to finance these subsidies means the government is ‘eating the cake and having it too’ - only it is borrowing its cake from the future. Because, these oil bonds have created liabilities for future.
Except for the illusion of softening inflation thanks to cheaper fuel, the government has achieved little from this financial jugglery. The value destruction has been immense during the entire process. At the average Sensex growth of 45% the trio IOC, HPCL and BPCL could have added over Rs 38,000 crore to their market capitalisation during last 12 months. At the same time, the growth in ONGC’s market capitalisation could have been tremendous, had it not been forced to share the subsidies.
The issue of the oil bonds will have serious long-term ramifications apart from the more visible financial impact. Cheaper fuel will inevitably increase wasteful consumption of petroleum products within the country resulting in higher import bill. At the same time, availability of subsidised fuels will hamper growth of alternatives or better technologies towards conservation of petroleum resources. Lastly, lack of competition from the private sector may lead to higher inefficiencies within the OMCs.

Govt-owned oil marketers pump up Q2 profitability

DESPITE facing a lot of problems — stemming mainly from subsidy on petroleum products — the Indian petroleum industry has put up an impressive show during the quarter ended September 2007.
The group, which includes companies engaged in crude oil production, refining and marketing, reported 23% spurt in aggregate PAT despite a mere 2% improvement in net sales. Profit growth was driven by strong operational performances by standalone refiners and private players. Other income also came handy as it jumped by 71% during the quarter thanks to foreign exchange gains due to appreciating rupee.
The main sub-group of companies that outperformed the sector was the state-owned standalone refineries. These companies — Mangalore Refinery (MRPL), Chennai Petroleum (CPCL) and Bongaigaon Refinery (BRPL) — were forced to give discounts to downstream marketing companies till September 2006 quarter but were relieved from the same since the quarter ended December 2006.
Thus, considering the lower base of last year, the group of three posted a huge 331% jump in PAT during the current quarter.
The two private sector refiners — Reliance Industries and Essar Oil — too came out with encouraging results. Thanks to higher refinery throughput and improved refinery margins, RIL posted a 28% PAT growth to Rs 3,837 crore.
The performance of the public sector oil marketing companies was dampened due to the reduction in the assistance they received from government and upstream oil companies. The aggregate oil bonds were lower by 17%, while the discounts extended by the upstream companies was down by 26%. However, despite these odds Indian Oil posted a better-than-expected 25% PAT growth. IndianOil’s refining margins during the quarter were substantially higher on y-o-y basis as the company had written off loss on valuation of inventory in the corresponding previous quarter. However, both BPCL and HPCL recorded fall in profits.
The group of companies in the petroleum exploration and production segment performed better lead by the industry leader ONGC. In this quarter ONGC became the first Indian company to cross Rs 5,000 crore in quarterly profits. However, the performance was not in line with the strong surge in the international crude oil prices due to ONGC’s discounts on the one hand and the rupee appreciation on the other. Since the billing is done in dollars, the domestic oil producers suffer when rupee appreciates against the dollar.
Going forward, the performance of state-run OMCs will continue to depend on the support they receive from the government. The standalone refineries, which had stopped offering discounts from December 2006 quarter, won’t enjoy the benefit of small base. Their performance will directly depend on the refining margins, capacity utilisations and the fluctuation in rupee. The private sector refiners — free from pricing restrictions — are likely to continue their strong performance. The upstream companies will continue to benefit from strong upsurge in oil prices, while some of the profits may get eroded due to higher rupee.
Manufacturing brake on IIP growth
Industrial production grew by 6.4% in September, significantly lower than 12% growth recorded a year ago. Deceleration in manufacturing and lower production of electricity was responsible for 11-month low growth figures. Twelve out of 17 two-digit manufacturing industries recorded a single digit growth while two industries recorded a decline in their production. Last year in the same month there were only five industries recording single digit growth and only one industry had reported a decline.
A fall in production of manufactured food products and transport equipment and parts has played a spoilsport in September 2007. Moreover, lacklustre performance by machinery and equipment other than transport equipment, non-metallic mineral products, metal products and parts and basic chemical industry has dragged the industrial growth further during this month.
Whether, it is a beginning of a downward trend or an aberration is yet to be seen. In October, industrial production is likely to be revived. The effect of higher festive demand may raise the industrial production. In addition, lower growth in October 2006 may help it record strong number in next month. But, still there are concerns over the progressive growth for the remaining months of the current fiscal. It has been observed that the production index is easing on m-o-m basis. Secondly, the industrial production during April-September 2007 has grown by 9.2%, lower than 10.8% in the corresponding period last year. Thirdly, credit offtake by industries from banks has decelerated.

Interview- BPCL: Fighting the odds

Indian petroleum companies are short of resources at a time when energy sector needs huge investments

SK JOSHI DIRECTOR FINANCE, BPCL

With crude oil prices at historic highs, for how long will the government’s policy of subsidies be sustainable?
The government is trying to shield the Indian consumer from the effects of the rising global crude prices. The burden has been distributed amongst the government, upstream oil producers and downstream marketing companies. Consequently, India is one of the few countries where retail prices have not risen significantly despite the surging prices in the international markets. Though the government has issued oil bonds and reduced excise duties, they are not sufficient. The burden on OMCs is increasing with every passing day, severely compromising their ability to generate resources required for future investments. Given this, the current policy may not be sustainable in the long run. At the same time, duties on petroleum products remain high and there is enough headroom to reduce duties further. However, the impact on government revenues and fiscal deficit need to be taken into account. One also needs to consider the implications of the oil bonds issued to companies. These are in the nature of a consumption subsidy and as such have a negative impact on efficient utilisation of resources. Anyway, oil bonds have only postponed the burden to a future generation. The government will have to necessarily address these core issues.

Being the second largest marketing company in India, what are your growth strategies?
To have a focus on each segment of the market, BPCL has adopted the Strategic Business Unit (SBU)-based organisational structure. We have divided our market into SBUs –bulk customers, LPG, retail, lubricants and aviation and a dedicated team ensures that we grow in all these five segments. This focus enables us to provide customised products and value-added services to our customers in each of these segments. We have pioneered new products such as branded fuels, loyalty programmes and value-added services at retail outlets. BPCL continues to retain its market leadership in the premium fuel segment. Similarly, the ‘Beyond LPG’ initiative has been aimed at leveraging our large LPG consumer population by offering them a range of products on attractive terms. Going forward, we believe that cleaner energy solutions will have an important role to play. BPCL plans to have a major presence in the bio-diesel value chain and in supplying ethanol-blended fuel.

How is your non-fuel retailing shaping up? What role does it play in your overall strategy?
As I mentioned earlier, BPCL is striving to be more than a supplier of fuel. Towards this end, considerable emphasis has been laid on the non-fuel offerings at retail outlets and in our ‘Beyond LPG’ initiative. We believe that this is a key component of the overall strategy. One of the segments where growth prospects are attractive is the highway sector. The segment sees different customer groups ranging from truckers to tourists. We have set up ‘Ghar’ outlets, which provide a range of services to meet the needs of almost all segments. Rest rooms, restaurants, etc. are some of the facilities, which have been very popular. Most of these large format outlets are managed by the company itself. We have realised that the customers have a greater faith in company outlets. In urban areas, the ‘In & Out’ stores at our outlets have seen encouraging footfalls and sales volumes. These offerings also translate into higher fuel sales.

What are your views on the strategic investments made by BPCL in sectors such as petroleum exploration and gas distribution?
BPCL has been an early mover in LNG and the city gas distribution businesses. BPCL has also entered the upstream exploration and production sector with a view to secure its crude and gas sources. Some of our early strategic investments include the equity stake in Petronet LNG and Indraprastha Gas, which have now become established players in the gas business. We also formed joint ventures for undertaking city gas distribution projects in Maharashtra, Uttar Pradesh and Gujarat. On the E&P front, our plans are at a nascent stage. We don’t have any experience in this field and presently we are just investors. We have working interest in around 24 blocks both in India and abroad. The gestation period in this business is quite long. We are therefore trying to build a balanced portfolio of assets while developing our expertise. We have bid for fields offered under the different rounds of bidding besides farming into existing blocks. Over time, we would like to venture out as an operator in our own right. To provide the desired focus we have floated a 100% subsidiary company to implement BPCL’s plans in this sector.

How do you view the strong appreciation of the rupee against the dollar? What is your bet on the exchange rate for the next two years?
As a refiner, we are interested in the spread between crude oil and petroleum products, which is the gross refining margin (GRM). These GRMs are dollar-denominated and so the margins get affected in rupee terms when the rupee appreciates. However, on the borrowings side, the appreciating rupee provides benefits as debt service burden of foreign borrowings comes down. Considering the current global economic conditions, we believe the rupee will continue to appreciate in the future. However, we cannot expect it to appreciate at the same pace as in the last eight to 10 months. If possible, we plan to increase our exposure to foreign borrowings to benefit from this trend.

What is the status of your new refinery at Bina? How will it augment your refining capacity by ’10?
Currently, we are growing at nearly one million tonnes in marketing volumes every year. We have a 12-million tonne per annum (mtpa) capacity at Mumbai, 7.5 mtpa at Kochi and 3 mtpa at Numaligarh, which adds up to 22.5 mtpa of refining capacity. We are expanding the Kochi refinery by another 2 mtpa. With the commissioning of the 6-mtpa Bina refinery, the group’s refining capacity will increase to over 30 mtpa by the end of ’09.
The work on the Bina refinery is progressing well and we have achieved around 30% physical progress. The entire debt portion has been tied up and we are currently in the midst of finalising the equity portion. Till date, commitments in excess of Rs 7,500 crore have been made and all long lead items have been ordered. We are confident of meeting the commissioning date and expect the refinery to come on stream by end-’09.

What cost management measures is the company taking to keep the business on track?
With the caps on our revenue streams, cost management has become an extremely important aspect of our operations. We have an ERP system to control costs and monitor performance and manage inventories. We have managed to significantly bring down the requirement of LPG cylinders per customer resulting in substantial savings. We have also fine-tuned the lubricants supply chain management with the help of ERP. We are now in the process of replicating this in the LPG business.
The single buoy mooring (SBM) facility at Kochi refinery will become functional by end-November ’07. We would then be in a position to handle very large crude carriers (VLCCs), which will help optimise the crude import costs. This is expected to benefit both the refineries at Mumbai and Kochi.

How has your experience been with the ethanol-blending programme? What are the challenges that need to be overcome to make it really effective?
Ethanol blending is an environmentfriendly initiative. Besides considering high crude oil prices, this also makes economic sense. The government has mandated oil companies to blend 5% ethanol with the petrol sold domestically. However, the challenge is to get desired quantity of ethanol.Besides ethanol, we are also exploring opportunities in bio-diesel. We believe that bio-diesel has a promising future and we are looking at forming joint ventures to support the initiative.

What are your capex plans over the next five years? How do you plan to finance it?
Over the next five years, our capital expenditure is likely to be in excess of Rs 15,000 crore. The money will go into areas like exploration and production, investment in joint ventures, and expanding distribution and marketing facilities and upgrading the two existing refineries.
Although internal generation has been affected due to the burden of the rising oil prices, we are confident of generating a significant portion of the resources needed from our operations. In addition, we may borrow to bridge the gap. Given that our debt equity ratio has traditionally been low, we would be able to fund our capital expenditure requirements.

Do you have any plans of growing inorganically? We are always open to new business opportunities. However, the focus remains on our core business of fuel marketing and the upstream exploration and production sector. We are already into the LNG and city gas businesses and both these businesses are expected to grow big in days to come. Another area where we have now become active is bio-diesel. We have plans to have a major role in the bio diesel value chain. We are exploring opportunities in the area of ethanol in Brazil along with the other PSU marketing companies.

Fireworks to continue...

India Inc may have reported a slower rate of growth during the September ’07 quarter. However, the future doesn’t seem to be that gloomy

THE Indian bourses are vying for altitudes which many of us may not have even dreamt of, thanks mostly to the enthusiasm of foreign funds, which have been pouring money into the Indian equity market. Global investors are gung ho about India’s growth potential, given the robust estimates of GDP growth. Given this, it is a worthwhile exercise to track the quarterly performance of the Indian industry, which forms a major chunk of GDP if we combine the share of manufacturing and services.
Revenue and profit growth are tapering off since the March ’07 quarter and picture was no different in the September quarter. The latest aggregate results strengthen our view that the corporate growth has peaked. Both in incremental as well as percentage terms, corporate India is witnessing a gradual pullback. In the September ’07 quarter, aggregate sales of 1,747 listed companies that declared results rose by 17% and net profit grew by 22%. This was lesser than the corresponding figures of 31% and 54% during the September ’06 quarter. The oil companies and banks do not form a part of this sample, as given their size and volatility in earnings, the real picture could get distorted.
Sales growth is on a continuous decline over the last four quarters and during the September ’07 quarter it was the lowest when compared with any of the quarters since the December ’05 quarter. The slowdown may appear to be a result of a higher base effect as the year-ago growth rate was very high. To know the facts, we studied the incremental change (year-on-year difference between absolute numbers) in the aggregate topline and bottomline.
On an incremental basis, topline shows signs of fatigue. In the September ’07 quarter, nearly half of the companies reported a higher incremental jump in sales reckoned year on year. In the corresponding quarter of the previous year, roughly two-thirds of the companies were able to do so.
The growth rates in operating and net profits are also on a downward trend since last year. The rate of growth in operating profit has come down to 18.4% during the second quarter of the current fiscal from 42% in the September ’06 quarter. By similar comparison, net profit growth has tapered from 54.2% to 21.9%. On an incremental basis, however, corporate India is still able to keep up the tempo as half of the companies reported absolute year-onyear rise in net profit, similar to the yearago quarter. The slower growth in sales and profits can be attributed to sluggish performance by majority of companies in the sectors including automobile, cement, IT, metals and textiles.
Operating margin weakened slightly from 18.8% in the year-ago quarter to 18.6% in the September ’07 quarter. Companies that witnessed a contraction in the margins were from various sectors such as sugar, textiles, non-ferrous metals, auto ancillaries, pharmaceuticals, dyestuff, and leather chemicals.
Other income continued to gallop and grew over 72% during the September ’07 quarter. This was mainly on account of the unrealised foreign exchange gains arising out of foreign currency borrowings. This notional other income boosted net profit, which grew 22% on a y-o-y basis despite rising interest and depreciation costs. Net margin expanded by 50 basis points to 12.3%. Do the second quarter results hint at the possibility of a slowdown in the future performance of Corporate India? The analysis of the quarterly results won’t be complete without answering this question.
Presently, the growth rates are indeed
slowing down. However, we at ETIG believe that this is just a temporary phase – a so called ‘inflexion point’ – before the next phase of high-speed growth sets in. Corporate India is sitting on a huge work-inprogress as a number of capacity expansion projects are under way in almost all the industries, particularly in petroleum refining, cement, steel, and automobiles. At the same time huge investments are lined up for building the infrastructure in areas such as petroleum exploration and production, power generation and electrical equipments, construction, heavy engineering and similar industries. As these capacities come online, they will provide the impetus for Corporate India to take the next big leap. The aggregate y-o-y growth rates may decelerate marginally during the second half of FY ’08, but the same are expected to pick up with the start of FY ’09.
Further, some of the sectors continue to post robust performance. Capital goods and power generation companies reported improvements in operating profit margins during the quarter ended September ’07. Entertainment and electronic media – a relatively smaller industry considering the number of listed players – put up an impressive show led by the excellent performance of the industry leader Zee Entertainment.
The future appears to hold some challenges of global nature for Corporate India and wading through these may prove to be a daunting task. The US dollar is weakening steadily and India may witness a sustained rise in the rupee over the next few quarters. This will dent profitability of exporters. Global crude oil prices have crossed $95 per barrel levels and may soon touch $100 per barrel. Though the price regulation in the domestic market will keep the rise in fuel prices under check, impact of a higher energy price is expected to percolate through an increase in prices of crude oil-based commodities. It appears that the way ahead is rather tough at least in the immediate future. However, the things are likely to improve in FY ’09. Particularly, industries such as oil and gas, infrastructure, capital goods, telecom and power generation appear to hold a promising future ahead. There will be outperformers in other sectors also. However, they will have to be thoroughly researched.