Stepping On The Gas

Even as fortunes of the petroleum industry remain clouded, natural gas is entering a golden phase

IF YOU consider the Sensex’s roller-coaster ride during 2008 as dramatic, then reversal in the fortunes of energy companies was nothing less than unprecedented. The spurt in energy prices in the first half of the year turned into a disaster in the second half, as crude oil lost nearly three-fourths of its value. In the process, crude once again became a commodity from being one of the hottest asset classes in ’07 and early ’08. The booming refining industry also came to a sudden halt as gross refining margins (GRMs) shrank after the Beijing Olympics in September ’07. Refining margins in the US Gulf — which were ruling above $15 per barrel in September ’08 — crashed subsequently and turned negative by the first week of November ’08. The price reversal in crude also had a dramatic effect on the domestic petroleum industry, which is dominated by state-run oil companies. These companies continue to suffer due to the government’s control on retail fuel prices, even as private refiners mint money, with their GRMs touching historic highs. PSU Navratna companies, which were once cash-rich, are likely to end the year with net losses. These companies, which paid over Rs 3,400 crore as dividends in FY07, had to cut that figure down to a mere Rs 900 crore in FY08. And 2009 could well be the first dividend-less year for them. However, the domestic natural gas industry tells a different story. India’s long-standing gap between demand and supply may narrow, as gas supplies begin from reserves of RIL, GSPC and ONGC on the east coast.

FUTURE OUTLOOK:
2008 is set to emerge as the first after 1983 to witness a fall in consumption of crude oil. Average global consumption is likely to remain at 85.8 million barrels per day (mbpd) compared to 86.1 mbpd in ’07. In the near term, crude prices are likely to stay at the current low levels. But towards the end of ’09, they should move above $60 per barrel. Until that revival, profitability of ONGC and Cairn India will remain under pressure. The fortunes of the refining industry continue to remain clouded in the short and medium term, which will affect Essar Oil, Reliance Petroleum, MRPL and CPCL. While existing refineries are running on low capacities, several new ones will be completed in ’09. So, we may see closure of old and simple refineries.
However, India’s natural gas industry is entering a golden phase with the availability of natural gas expected to double in two years. This will help gas transportation companies like Gail, Gujarat Gas, GSPL and Indraprastha Gas, as well as ancillary industries such as CNG cylinder manufacturers. This section of the industry will witness healthy profit growth in the near term.

Interview-GMR Infra’s group: Still Going Strong

Despite the credit crunch & high interest rates, GMR Infra’s group CFO A Subbarao believes now is the best time to invest in infrastructure

Being an infrastructure player, are you not feeling the pinch of the credit crisis and rising interest rates?
The majority of our projects are no longer in the investment phase and are nearing their revenue-generation phase, and this is helping us. For example, in the roads sector, out of the four ongoing projects, one has already been commissioned and the other three will be commissioned over the next three months. The pending capex on these projects is just Rs 300 crore by February ’09. In the power sector, all our three projects with 800 mw installed capacity are currently in operation.
There are several new power projects in the pipeline, but most of them are only in the preliminary development phase, where we are seeking land clearance, environmental clearance, fuel security etc. Only two projects — the 300-mw hydel plant at Badrinath and 1,050-mw coal-based project in Orissa — are nearing financial closure, where the total capex required will be Rs 6,000 crore.
In the case of airports, the Hyderabad airport is already operational and we won’t incur any more significant capex on it in the near future, as we still have spare capacity. At Delhi airport, we have already achieved financial closure with Rs 5,000 crore of debt. Both the airports are now generating strong cash flows. Thus, most of our projects are well-funded and the revenue streams have started.

But wouldn’t high interest costs affect the viability of your existing or new projects?
Not really. For all our projects in the construction phase, we borrow at fixed rates, which will be reset only after 3-5 years. So currently, the average cost of debt comes to only 9.6% for the group. For our new projects, we will have to borrow at some 300 bps higher, but now we will go for floating rates. Again, that will not significantly affect our return on investment. For example, for our 1,050-mw Orissa power plant, we need to borrow Rs 3,500 crore. The debt will be drawn gradually over the three years of project execution, so the average debt comes to around Rs 1,750 crore. Hence, with 300 bps higher interest, our project cost will go up by Rs 150 crore, which is just 3.3% of the total project cost of Rs 4,500 crore. Another important factor that many people are ignoring is that although interest costs are going up, the cost of construction is coming down sharply. Prices of cement and steel, or margins of EPC contractors are all very low, which can save 20-25% of the project costs. This will far outweigh the loss on account of higher interest. Again, interest costs are cyclical; they will decline soon. In fact, I think this is the best time to start new projects to create a low-cost infrastructure for the future.

What future plans do you have for the Hyderabad and Delhi airports?
Since we have taken both these airports and adjoining land on a 60-year lease, we are working on significant long-term plans. We plan to develop these airports as regional hubs and international transit points. The available land — nearly 6,500 acres in Hyderabad and around 250 acres in Delhi — will be used to develop aero-related businesses, which will help in attracting more traffic. In the immediate future, we plan to set up a maintenance, repair and overhaul (MRO) business at Hyderabad airport with around Rs 200 crore investment by March ’10. We have tied up with Malaysian Airways as the technical support partner, and we are looking for a domestic airline as the anchor customer to join as a partner. This will be the first MRO service in India and considering that today, nearly 500 aircraft in India visit overseas destinations for these services, we expect to do well. On the rest of the land in Hyderabad, we plan to develop an international city with all facilities such as hospitals, hotels, office complexes, etc. We are currently going slow on this due to the economic slowdown.

What is the revenue generation capacity of your airports?
If we look globally, airports such as Singapore or Hong Kong earn $17-18 per passenger, which can be as high as $50 per passenger in Europe, taking both aero and non-aero revenues together. So, we have set $20 per passenger as a target for generating revenues from our airport business. The user development fee (UDF) is a special and temporary charge and is not considered for this purpose. We are assured of 17% return on investment for the Hyderabad airport, and 11.33% in the case of Delhi airport, considering only the aero revenues. Non-aero revenues such as retail, commercial, advertising, parking and cargo — which comprise over 60% of an airport’s total revenues — are not part of these calculations. Only in the case of Delhi airport, which is a brownfield project, 30% of the non-aero revenues are added to the aero revenues for this purpose.

Which of your verticals will drive the future growth of GMR group?
Our power business will continue to drive future growth. This business will perform very well over the next three quarters, with all our 800-mw capacity running continuously, which can generate Rs 2,000 crore in revenue annually.
Further, the European company, InterGen, in which we picked up a 50% stake earlier this year, has a 8,000-mw running capacity with projects of 4,000 mw in the pipeline. We are not consolidating these revenues right now, as the investment is held through convertible debentures. Once we convert these bonds into equity shares, we will be able to consolidate the revenues. That will boost the power segment’s revenues substantially. Besides, the 1,050-mw Orissa power plant is scheduled to be commissioned in March ’10. We also want to add another coal-based 1,000-1,500 mw power plant, probably on the west coast of India, by mid-’11, for which we are trying to acquire stake in some coal mines in Indonesia.

(For the complete interview, log on to www.etintelligence.com)

NITIN Fire Protection Industries: All Fired Up

NITIN Fire Protection Industries has emerged as a beneficiary of the increased awareness among Indian corporates about protection from fire, following the recent terrorist attacks in Mumbai. The company has recently bagged several contracts from various banks and hotels for fire alarms and fire fighting systems, and has an order book of Rs 70 crore under this business segment. Going forward, its order book is likely to grow further. The company’s seamless cylinder business is also doing well and currently has pending orders worth around Rs 30 crore. For FY09, the company is expected to produce around 140,000 CNG cylinders at its plant in Vizag SEZ, against the installed capacity of 500,000 units, to generate revenues of around Rs 80 crore. This includes its CNG cascade business, which is also generating high demand from companies setting up CNG stations across the country. Considering that the number of cities with CNG networks is rapidly increasing in India, over the next couple of years, the demand growth for cylinders is likely to remain strong.
In the first half of FY09, the company’s net profit surged by 115% to Rs 19.5 crore, while its revenue doubled to Rs 124 crore. The company’s OPM rose by 200 bps to 20.6% in H1 FY09, which is likely to continue in the second half as well. At the current price of Rs 239, the scrip is trading at a P/E of 10.1 based on its consolidated net profit for trailing 12 months.

When Will The Tide Turn?

The Business Confidence Index has fallen to a five-year low of 119.9 as pessimism spreads in India Inc. However, governments across the world are taking extra efforts to combat the slowdown. It remains to be seen how these measures play out in the coming quarters

INDIA INC’s business confidence has ebbed further. This is reflected in the 66th round of the ET-NCAER Business Expectations Survey (BES) for the quarter ended September ’08. The Business Confidence Index (BCI) has dipped to a five-year low of 119.9, as companies’ expectations have worsened on all the four parameters, viz overall economic conditions, financial position, investment climate and capacity utilisation levels. The index stood at 154 in January ’08, but has consistently deteriorated since then.

Although all these four criteria — which carry equal weightage in the BCI — suffered, unlike in the previous round of the survey, the dip in confidence in the current round has not been uniform across regions, sectors or size of companies. With the passage of three months since the previous round of the survey, many respondents seem to have given in to the barrage of negative news. In fact, several groups, which had remained bullish earlier, have now turned bearish. At the same time, those respondents who had posted the largest fall in confidence in the previous round have mostly remained unchanged.

ALL’S NOT LOST
The services industry has seen a healthy revival in sentiment to emerge as the sector which is most hopeful about the overall economic conditions. In the previous round, this sector was the most pessimistic about overall economic conditions. The intermediates sector is the least affected, as it remains the most optimistic about the current investment climate. Nevertheless, the sector has witnessed a fall in respondents who expect a growth in production and sales over the next six months. However, the capital goods industry, which had seen the maximum decline in confidence level in the previous round, has turned out to be the biggest loser in the September ’08 quarter as well.
There has been a marked increase in the number of respondents expecting a growth in sales over the next two quarters. Despite this fact, the services industry remains the most pessimistic about the investment climate and financial position over the next six months. With the increased optimism about higher production and sales, the expectations on the profits front over the next six months have also increased. However, there has been a fall in the number of respondents expecting profit growth in excess of 10%. WEST, SOUTH KEEP THE FAITH
In terms of regional comparison, the West and South have witnessed a surprising improvement in business confidence across all criteria. The southern region has emerged as the most optimistic, but the western region, which was the most pessimistic in the previous round, continues to languish at the bottom, despite its improvement in confidence. The North has witnessed weakness on all counts, with a particularly steep fall in outlook on the current investment climate.

SIZE MATTERS
Surprisingly, the smallest of companies in the group have joined the largest ones to register an improvement in confidence.
Companies with turnover of less than Rs 1 crore, as well as those with turnover exceeding Rs 500 crore, are more optimistic about the economic conditions, investment climate and capacity utilisation, but they don’t feel that their financial positions will improve.

PUBLIC VS PRIVATE
Public sector enterprises, which were buoyant in the previous round of the survey, also seem to have succumbed to the pessimism. This is reflected in a fall in their business confidence. The BCI for public sector companies has fallen to 120.7 in the September ’08 quarter from 149 in the June ’08 quarter, and the sector is now most pessimistic about the current investment climate and financial expectations.
The listed companies in the private sector, which figured at the bottom in terms of business confidence in the previous round, continue to maintain their position, with little change.

PRICE WATCH
Given the current economic downturn, there has been a decline in the number of respondents reporting a rise in raw material costs. The percentage of respondents which witnessed a hike in raw material prices during the preceding three months fell to 67.5% in the September ’08 quarter from 75% in the June ’08 quarter. Similarly, only 62% of the respondents now expect a price increase over the next six months compared with 70.4% earlier.
As a result of the worsening outlook, the labour market is also expected to remain subdued. Respondents reporting a wage hike or an increase in number of workers have come down sharply.
Still, there has been an increase in the percentage of respondents expecting a wage increase over the next six months.

KEEPING FINGERS CROSSED
As the recession has spread to major global economies, India Inc seems to be uncertain about its immediate economic future.
This is mainly due to a decline in those sections which had not fallen steeply earlier. However, several sectors of the industry hope to post healthy growth over the next six months. Governments across the world are taking extra efforts to combat the slowdown and have introduced several measures to this effect.
The results of these efforts will become visible gradually over the next 6-9 months. Till then, India Inc needs to wait and watch how these measures will affect its confidence in the coming quarters.

Tradeable bonds help fertiliser cos rock, stocks rise up to 24% in a week

SHARES of fertiliser companies are seeing renewed interest on bourses, following the government’s move to make recently-announced fertiliser bonds 2022 tradeable.
As part of the stimulus package announced for various industries, the Union government had announced 7% Government of India Special Bonds 2022, for the fertiliser companies. The special bonds are transferable and eligible for ready forward transactions (Repo), improving their market demand. Better liquidity means the companies will not have to sell the bonds at a steep discount as was the case earlier. Though the government has issued fertiliser bonds in the past, they did not have a repo status.
Over the past one week, shares of Tata Chemicals, Chambel Fertilizer and Chemicals, Gujarat Narmada Valley Fertilizer Company (GNFC), Nagarjuna Fertilziers (NFCL), Managalore Chemicals and Fetilziers, Rashtriya Chemicals and Fertilizers (RCF), Zuari Industries and Coromandel Fertilizers, to name a few, have risen around 24%. On Monday, frontline stocks in the sector were up between 3-7%.
“The move will improve liquidity in these (fertiliser) bonds and will help the industry sell them at par. This, in itself, is a major boost for the cashstrapped industry, which could not earlier liquidate them due to huge discounts of around 10% earlier,” said US Jha, CMD of Rashtriya Chemicals and Fertilisers (RCF).
Industry sources say the government has advised fertiliser companies to borrow under the collateralised borrowing and lending obligations (CBLO) scheme for the next couple of months till the effect of the recent rate cuts become visible. Once the interest rates ease, these companies will be able to offload their bonds at par value, without incurring any loss.
“The government has assured us that these bonds will be made eligible under CBLO and we are expecting a RBI notification soon,” a senior official with a leading fertiliser company said. Once eligible under CBLO, fertiliser companies will be able to raise cheaper loans by pledging these securities with banks. Fertiliser bonds are classified as eligible investments for provident funds, gratuity funds and superannuation funds, as per a ministry of finance order.
Similarly, investments in special bonds by insurance companies are eligible under classification of other approved securities, the notification added. With India’s agri production touching record highs, most fertiliser companies are in the midst of an expansion drive. State-run GNFC plans to infuse around Rs 3,000 crore in capacity expansion over the next three years.
Tata Chemicals has already spent Rs 350 crore on Babrala and Haldia expansion and debottlenecking and it may soon kick-start its debottlenecking plans which had been postponed due to the ongoing credit crunch. Tata Chem had earlier said it would debottleneck its 3,000-tonne per day Babrala plant to add 500 tonne per day of urea at Rs 200 crore. Urea maker Nagarjuna Fertilizers & Chemicals has also plans to set up overseas plants and foray into complex fertilisers.
Nagarjuna plans to set up an urea plant in Nigeria with a maximum capacity of two million tonnes, and is in talks to tie up gas supplies in the Middle East and other regions.

Agriculture sector: Riding The Boom

Given the slowdown in manufacturing and services segments, the agriculture sector is set to support India’s economic growth. But will this benefit cos which provide vital inputs to the agri sector?

COMPANIES PROVIDING inputs to agriculture and related activities are back in vogue, given the deceleration in manufacturing and services sectors. The major companies operating in this space have performed well on the bourses in FY09 so far, outperforming the BSE Sensex. ETIG brings you a first cut on this sector and various players therein.
Following the global economic crisis, a slowdown is visible in manufacturing as well as services sectors in India. Be it in textiles, steel, construction, automobiles, gems & jewellery or IT & IT-enabled services, finance, hospitality, travel & tourism — the news about lay-offs and slowdown are doing the rounds everywhere. Also, after growing steadily till September ’08, India’s merchandise exports dipped by a whopping 12% in October ’08. Against this backdrop, economists are looking at the agriculture sector to spring a surprise and support India’s economic growth in the second half of FY09. This is expected to benefit the companies which provide vital inputs to the agriculture sector. The agro sector needs a number of vital inputs for its survival and growth, which include fertilisers, micronutrients, pesticides and seeds. Though fertilisers play an important role in agriculture, the sector is highly regulated in India and thus, has limited ability to benefit from any growth in the agro sector. Hence, we are not considering this sector here.

GROWTH DRIVERS FOR AGRICULTURE:
The purchasing power in rural India is likely to remain healthy, despite the global economic turmoil. The sector is now attracting direct and indirect investments from the private sector. The minimum support price for the kharif season has also been attractive. At the same time, the government’s loan waiver scheme earlier this year and its continuing expenditure on developing the rural economy will also provide a positive impetus to the domestic agriculture sector.

AGROCHEMICALS:
Agrochemicals have become an integral part of the development process of agriculture and their use is expected to increase manifold in India. There are two growth drivers in this business. The first one is increase in labour cost of farm labour and continuous decrease in the availability of farm labour. The second is increasing awareness among Indian farmers regarding usage of new products.
Due to availability of cheap technical manpower and lower cost of production, India has become a manufacturing hub of agrochemicals exporting to western countries. Nearly half of the pesticides manufactured in India are exported to various countries. United Phosphorus is India’s largest agrochemicals company, which has expanded into various countries through acquisitions in the past few years. Bayer CropScience is the market leader in the domestic pesticides market with well-established products. The company more than tripled its profits in the first half of FY09. Rallis has also performed well over the past four years after its turnaround and posted a higher operating profit in H1 FY09 than during entire FY08. It is one of the very few companies whose valuation in terms of P/E multiple has not suffered due to the current market turmoil.

SEEDS:
Many countries, including India, give greater priority to high agricultural productivity. This is possible only by increasing the genetic potential of seeds on a continuous basis to increase yields. As a result, expansion of the seeds industry has taken place along with growth in agricultural productivity.
Hybrid and genetically modified seeds are increasingly being used in India to improve agricultural yield. Advanta and Monsanto are the leading players in this business, although numerous other players also operate in this space. Monsanto has divested its sunflower seeds business and part of its herbicides business to focus only on hybrid corn seeds and glyphosate herbicide. On the other hand, Advanta is trying to emerge as a global player in the seeds business, following in the footsteps of its parent company, United Phosphorus.

GOOD H1 FY09:
The agro inputs industry had an exceptionally good first half as the demand for agrochemicals continued to rise even as prices continued to move up. Due to the sudden spurt in demand, there was a shortage of pesticides in several parts of the country. As a result, the industry enjoyed higher sales and margins.

ALL’S NOT WELL:
However, this industry has its own set of woes. When prices were increasing, the industry players built up raw material inventories — at times paying upfront for future deliveries. Now, with prices crashing steeply, these companies will take a hit on their margins. The 15% demand growth witnessed so far this year in domestic agrochemicals may not continue in future.
Even on the exports front, things may not work out well for the industry, despite a weak rupee. Due to the ongoing credit crisis, a number of overseas importers are unable to secure letters of credit required for importing materials, thereby resulting in a fall in demand for domestic manufacturers. As a result, companies may achieve their sales target in the second half based on healthy domestic demand, but their profit targets will take a hit.

Dig Deeper For More

The current market turmoil has pulled down the high valuations that E&P companies were enjoying just a few months ago. But their prospects seem promising due to strong order books

GLOBAL CRUDE prices have crashed over the past few months and so has the stock market. But irrespective of the prices, the search for ‘black gold’ continues unabated across the world. A number of countries are battling falling crude oil production, while in India, which imports over 70% of its requirement, energy security is at stake. Recently, the government awarded 44 oil blocks under the seventh round of the New Exploration Licensing Policy (NELP) and is preparing for the eighth round in early ’09. This indicates that the boom in the exploration and production (E&P) industry is unlikely to slacken in the current economic downturn.
The trend is already being reflected in the fattening order book positions of domestic companies operating in the E&P support industry, which are helping oil majors in their exploration efforts. A multiplicity of projects and paucity of equipment means that in several cases, these companies secured confirmed contracts for their equipment, even before their actual delivery. Aban Offshoreis India’s largest owner of offshore drilling rigs with a fleet of 20 drilling vessels and one floating production unit (FPU). Its results for the preceding four quarters indicate the upturn in its earnings, which is likely to continue in future. Drilling charter rates, which had reached unprecedented levels earlier, are now off their highs in global markets. But Aban Offshore already holds firm charter contracts worth over Rs 4,000 crore for the next 12 months, which is nearly three times its turnover in the past 12 months. Also, for half of its vessels, the charter rates are locked for more than 24 months, giving stability to its future revenue growth. Great Offshoreis India’s second-largest offshore support company, operating a fleet of 41 vessels, including offshore support vessels (OSVs), drilling rigs and a construction barge. The company posted uninspiring results in the preceding two quarters due to changes in accounting of gains and losses in foreign exchange (forex). The company entered into port management and other related services via acquisition of a couple of companies on India’s east coast, adding another 19 vessels to its fleet. It is adding more vessels and expanding into marine construction to boost growth. Jindal Drillingentered into joint ventures with Singapore-based Discovery Drilling and Virtue Drilling, respectively, both of which have secured firm contracts from ONGC for offshore drilling rigs under construction. Of these, Discovery Drilling’s rig has commenced its contract with ONGC for three years, while Virtue Drilling’s rig will be deployed from mid-December ’08 for five years. These contracts will add significant revenues to the company on a consolidated basis. Dolphin Offshoreoffers marine and subsea engineering services, mainly to ONGC in western offshore. After working for a long period as a sub-contractor on ONGC’s offshore EPC contracts, the company has recently become eligible to bid for them as the main contractor. The company sold off two of its old vessels and its office premises over the past 12 months, which has boosted its numbers. It carries an order book of Rs 400 crore to be executed by December ’09. Shiv-Vani Oilis India’s largest onshore exploration support company. Onshore exploration is more of a local industry unlike offshore exploration, which is an international industry. So, the company faces little competition in India, which is reflected in its order book of Rs 3,600 crore to be executed over the next three years. The company’s cumulative revenues for the past three years were less than Rs 1,000 crore. It already has 34 drilling rigs with six more on order. All these 40 equipment will be deployed by end-FY09. Seamec, the Mumbai-based owner of four multi-support vessels (MSVs), has put up a disappointing show over the past 12 months. The upgradation of the vessel it purchased was delayed by nearly a year, while another of its vessels remained out of waters due to an accident. To make matters worse, a couple of its clients filed for bankruptcy in the US, making dues irrecoverable. However, it seems to be back on track now, with all its four vessels deployed gainfully. As the company’s vessels are used in sub-sea engineering, repairs and maintenance, the crash in crude oil prices is unlikely to impact it.
The current weakness in the rupee is beneficial to all these companies, which are net earners of forex. However, the presence of foreign currency loans on their books means they will have to write off the losses due to forex fluctuations. A high debt-equity ratio can be a big concern for the companies operating in this industry. However, they have secured revenue sources with sufficiently high interest-coverage ratios. Also, one must take into account the current scenario, where debt is the only way of raising finances for these fast-growing companies. The current market turmoil has pulled down the high valuations these companies were enjoying just a few months ago, which offers a good entry point for long-term investors.

ALPHAGEO India: On Shaky Ground

ALPHAGEO India, one of the largest onshore seismic service providers in the private sector, recently obtained a Rs 43.7-crore contract from ONGC to provide seismic data in Nagaland over a period of one year. Considering the company’s FY08 net sales of Rs 82 crore, the current contract amounts to over half of its annual turnover.
Last year, the company obtained a 3D seismic data acquisition contract from Oil India in Assam and Arunachal Pradesh. However, one of the contracts had to be foreclosed due to operational constraints posed by socio-environmental problems. The company defaulted on the other contract, paying liquidated damages of Rs 2.6 crore. The company will complete these contracts during the current financial year. It has also obtained a contract from Naftogaz to gather 3D seismic data in the second half of FY09.
Since the company’s business is contract-based, there are significant fluctuations in its q-o-q earnings. During the first half of FY09, the company posted only 10% higher revenue at Rs 45 crore. Its net profit fell by 5% to Rs 8 crore due to a fall in operating margin and rise in depreciation.
The company’s operating margin has remained range-bound in the past between 46% and 50%. Its current market price of Rs 88.25 is below its book value and translates into a P/E of 3.7. Although the company operates in a rapidly growing industry with healthy order book position, its ability to complete contracts on time is not fully proven, making it unattractive for long-term investment.

Interview- Rashtriya Chemicals & Fertilisers Planting Dreams

Recent changes in the policy for fertilisers are welcome, but some concerns remain

How has the domestic fertiliser industry shaped up over the past few decades?
The fertiliser industry has always been a strategically important industry for India due to its role in ensuring India’s food security. Ever since the pre-independence era, the government has had an interventionist policy with the aim of keeping the industry under its control. Even after liberalisation in 1991, fertiliser remained the only sector which bypassed reforms. As input prices shot up and the government didn’t hike fertiliser prices, the subsidy burden became manifold. But rather than tackling the problem in a straight-forward manner, policy makers started squeezing the industry in a bid to control their subsidy bill and kept fertiliser prices unchanged. As a result, the investment and capacity addition in this industry came to a standstill. The domestic fertiliser industry has not added any fresh capacity since 1999.
The past one year has been extraordinary, as the prices of fertilisers and their inputs shot up abnormally. As a result, the subsidy bill, which used to stay at Rs 10,000-20,000 crore annually, jumped up to Rs 50,000 crore in FY08 and this year, it is expected to cross the Rs 100,000-crore mark. At present, in phosphatic and potassic fertilisers, 80% of realisation comes from government subsidy. In the case of urea, it is 55%. This is unprecedented with no parallel in history. Just three years ago, only 20% of the fertiliser industry’s revenues used to come from subsidies and 80% from the market.

Fertiliser and input prices have crashed since the government changed its policies for fertiliser subsidy. What does this mean for the industry? When the government realised that its fertiliser pricing policy had made the sector unattractive for investors, it made some policy changes, hoping to attract investments in the fertiliser sector. For the first time, there was a departure from the cost-plus method, linking the subsidy payments to benchmark import parity prices. Earlier, there used to be two subsidies— one for domestically-produced fertilisers and another for imported fertilisers. But now, there is just one subsidy linked to the import parity prices. These is an important departure from the earlier policies, which is a good sign. However, there are certain concerns, particularly due to the recent crash in prices in the international market. Now there is a need to fine-tune the cap and floor prices to make it relevant in the current scenario.

Over the next five years where will RCF’s growth come from? What can retail shareholders expect from the company?
We have lined up several new capacity additions over the next five years that will add to revenues. Two of our plants were shut down in Trombay — a 300,000-tpa urea plant due to lack of gas, and a 350,000-tpa complex fertiliser plant due to an accident. Both these plants will be up and running by mid-’09. A further 2.5 lakh-tonne capacity will come on stream from the debottlenecking of the Thal plant and around 2.5 lakh tonnes of DAP capacity will come up in Rajasthan. Similarly, some of these large capital projects will capitalise in five years’ time, which includes expansion of more than one million tonne at Thal, revival of the Barauni unit, coal gassification and some joint venture projects. We may not have resources for all these large projects, but whatever materialises first, we will proceed with that. Profitability is limited in the fertiliser sector. We have been distributing nearly 40% of our profits by way of dividends. However, due to our huge equity base, that doesn’t result in an attractive dividend yield. We can’t raise the payout because we need some profits to plough back into the company. We are investing in our plants and good projects to create long-term value for our shareholders.

Increasing natural gas availability is expected to benefit the fertiliser industry. What is the ground reality?
At the moment, the requirement of natural gas-based fertiliser plants is 42 million metric standard cubic metres per day (mmscmd), against the supply of 28 mmscmd. Then the revamp, conversion of naphtha-based plants to gas, debottlenecking, brownfield expansion and so on will bring up more demand. At the same time, the availability of natural gas is expected to grow by 15 mmscmd by mid-’09, as Reliance Industries’ KG basin fields start production. So, as per the government’s current stand of giving first priority to the fertiliser industry, this will be entirely consumed by the industry against the existing shortfall. It will bring down the government’s subsidy burden, while the industry will benefit from higher volumes.

Is diversifying away from fertilisers a viable option for RCF?
As our core area has strategic importance for the country, we will have to continue with that. But at the same time, we are investing in the chemicals sector. We recently ramped up all our chemical plants. We will be adding an argon plant at Thal this year and are revamping methanol and nitric acid plants. RCF became the first company to introduce Rapidwall load-bearing panels made from gypsum, which is a substitute for bricks in building houses. The commercial production is expected to start by January ’09. We have set up a joint venture with Fertilisers and Chemicals Travancore (FACT) for the gypsum project. We are also planning to foray into wind power. However, since fertiliser projects are highly capital-intensive — for example one ammonia-urea plant will cost Rs 4,500 crore — they will get a larger share in our capital expenditure plans.

The government is also trying to revive some old fertiliser plants, which were earlier shut down. How far is this feasible technologically?
When you talk of revival of old plants, it is not really a revival. It is basically setting up a new plant at the same location. So, the only thing from the old plant that will be put to use is the land and supporting infrastructure. The existing machinery, if any, will have to be replaced with totally new equipment. As such, the capital expenditure will be huge. At the moment, the government is reviving one plant at Barauni through the public sector, for which, a special purpose vehicle has been set up between RCF, National Fertilisers and Kribhco. The economics of these plants will greatly depend on the availability and price of natural gas.

(For the complete text of the interview, log on to www.etintelligence.com)

Aries Agro: Reaping The Gains

THE expansion project of Aries Agro, the Mumbai-based manufacturer of micro-nutrients for agriculture, continues to be on track as it inaugurated its seventh plant at Lucknow recently. Earlier this year, the company had inaugurated one plant at Hyderabad and another at Ahmedabad. This took its production capacity to 84,600 tpa compared to 21,600 tpa at the time of its IPO in December ’07. But the company is deferring its eighth plant in Panvel to March ’09, as it has sufficient capacity for this year and it also wants to benefit from falling lease rentals. The company has launched 40 vans for mobile marketing, which will be scaled up to 100 by the end of December. Golden Harvest, the company’s 75% subsidiary in the UAE, has also commissioned production since November '08.
The company typically derives 45% of its annual revenues in the first half of the financial year and 55% in the second half. Taking into account its revenue of Rs 54 crore in the first half, the company appears well-poised to achieve its target of Rs 125 crore in FY09. It plans to sell over 45,000 tonnes of products in FY09, compared to 24,600 tonnes in FY08. Aries Agro’s profit in the first half of FY09 was adversely affected due to a rise in raw material expenses. Input costs jumped 44% even though the company scaled down staff and other manufacturing costs. However, the company implemented a price hike in mid-October, which should help it to improve its margins. The company imports a major chunk of its raw materials. But it had stocked on inventories heavily in June and July. So, it no longer needs to import any raw materials this fiscal, which will safeguard it from the rupee’s fall versus the dollar. Most of the company’s products are slow-starters, as establishing concept and gaining farmers’ acceptance takes time. In view of its additional capacities, aggressive marketing strategies and unique position in the domestic market, the company appears to be an attractive pick for long-term investors.

Bold. But Beautiful?

Quite a few companies are commanding triple-digit P/Es even in these turbulent times. Are they really worth it? Ramkrishna Kashelkar explores

EQUITY MARKETS across the globe, including India, have gone into a tailspin following the subprime implosion in the US. The plunge in the Indian stock market has been more or less in line with what is happening everywhere.
Although the earnings of Indian companies haven’t taken a major hit, their valuations have crashed. So, a leading company like Reliance Industries (RIL), which commanded a price-toearnings (P/E) multiple above 30 in January, is now being valued at just nine times its earnings, despite a steady rise in its profits over the past four quarters.
The P/E multiple is the most widely tracked indicator, reflecting how much premium an investor attaches to a company’s trailing earnings or net profits. It also captures the expectations of investors about the company’s future growth. Hence, it is but natural that the P/E multiples of most companies have crashed in the current uncertain times.
But surprisingly, quite a few companies are still commanding triple-digit P/Es. Though a number of BSE ‘A’ group companies too figure in this list, one wonders if these are instances of high investor confidence or just speculative interest.
MMTC — a public sector company where the government holds 99.33% of its 5 crore equity shares — has a public shareholding of less than 11,000 equity shares, or 0.02% of the total. For the past one year, the average daily volume in this scrip has been just 541. It is this illiquidity which has enabled the stock to soar beyond what its current fundamentals support. Reliance Natural Resources (RNRL) and Adlabs Films are two companies from the Anil Dhirubhai Ambani group which figure in the list of richly-valued companies.
RNRL is fighting a court case over the supply of natural gas from RIL and only a win there will help it generate substantial revenues and profits. But excluding this, its existing business model cannot justify the current valuations.
Adlabs Films had posted healthy profits in FY08, but its numbers in the first half of FY09 are significantly lower due to the amalgamation of its radio business. Although its current market price is just 1.25 times its book value, the return on capital employed (RoCE) has steeply fallen over the past four years and is a major cause for concern for the company.
Essar Oil commissioned commercial production at its 10.5 million tonne per annum (mtpa) refinery only in May ’08. Hence, its earnings for the trailing 12 months appear low, bloating up its P/E multiple. The company has posted a net profit of Rs 56 crore in the first half of FY09.
The economics of the global refining industry have worsened significantly of late and even if the company is able to repeat this performance in the second half, its current market price will be 90 times its full-year earnings.
Ispat Industries is highly leveraged, with its debt component being 4.5 times its equity. The company posted a minuscule profit in FY08 after a gap of two years. With interest costs soaring in the September ’08 quarter, it again reported a loss. Despite all these factors, the company continues to be one of the favourites among derivatives traders, which has helped the stock remain at high levels.
There are quite a few companies with net losses in the trailing 12 months which are trading at high prices. Most of them are assetrich companies with high brand value. Since these assets have a certain replacement cost, their market capitalisation is not likely to fall below a certain level, even in difficult times. Some of them are even making healthy cash profits, but high depreciation is pushing them in the red. These include companies such as the three oil marketing companies IndianOil, HPCL and BPCL, Aditya Birla Nuvo, Tata Teleservices Maharashtra and GTL Infra.
Jet Airways, which was cash positive in FY08 despite a net loss, incurred heavy cash losses in the quarter ended September ’08 due to high fuel and operating costs and a weak economic environment. A downturn in textiles and real estate industries hit Bombay Dyeing, which posted losses in three of the four preceding quarters.
Dozens of companies are trading above P/E of 100 — or even 1,000 in some cases — among the smaller ones. But they continue to remain much more obscure compared to the larger ‘A’ group companies. Even among these ‘A’ group companies, we find little justification for such high valuations in most cases.
However, in some cases, the asset-rich nature of business, positive cash flows and high brand value support the valuations of these companies. Investors should exercise caution while picking up such scrips.

India Inc’s Q2 results confirm investors’ worst fears that the pain will continue in the months to come.

ANOTHER QUARTER has gone by and the results have hardly surprised anyone, least of all the stock market. The slowdown in India Inc’s profit growth, which had become visible after the first quarter (Q1) of ’07, continues unabated as we near the end of calendar year ’08. And there’s little hope that the tide will change in the near future. The globe’s worst financial crisis has pushed the world’s largest economies into recession with countries like the UK and US witnessing contraction of their economies. Consumer spending in the world’s largest economy — the US — has fallen sharply as a number of large retailers posted double-digit fall in sales during October ’08. Globally, a number of companies are cutting down operations and laying off employees. The unemployment rate has already reached a 14-year high of 6.5% in the US, which is likely to worsen. To ease the credit crunch, central banks across the world are resorting to interest rate cuts, besides injecting cash into the system. However, these attempts have hardly yielded positive results so far.

EXPANSION BINGE:
India Inc is not likely to escape the mayhem unscathed. Encouraged by the strong economic growth of the past five years, cheap and abundant credit, coupled with prevailing bullish sentiment, India Inc (here we are referring to non-financial companies) embarked upon perhaps the biggest-ever spend on capital expenditure (capex) in the country’s history. Companies across sectors either went for aggressive capex or acquired companies, especially outside India, to achieve a global scale and footprint. This spending binge was initially financed by strong internal accruals, but as their ambitions rose, most companies resorted to debt financing, including external commercial borrowings (ECBs). The chicken has now come home to roost and India’s profitability is now being hit by debt servicing and other recurring costs related to capex. Besides, companies with high level of outstanding ECBs are being haunted by mark-to-market losses on their dollar- or euro-denominated debt.
The difficulties have been further compounded by the economic slowdown and falling demand for goods and services across sectors. If two years ago, demand was ahead of supply, now companies are facing over-capacity across-the-board. This has adversely affected operating margins.
Even as their internal cash generation is on a downward spiral, companies are being forced to increase cash outlays in the form of interest payments and purchase of capital goods. For instance, during the past two years, leading companies such as Reliance Industries (RIL), Tata Steel, Tata Motors, Hindalco Industries, DLF, Suzlon Energy and Larsen & Toubro (L&T) had higher cash outflows on account of investment activity, compared to the cash they generated from operations. When a company has higher capex than its operating cash flow, it needs to either borrow or dip into its reserves or cut dividends. And in the current scenario, where interest rates have risen and access to credit is restricted, a high dependency on financial institutions adds to the risk. Again, the economic downturn may affect the existing cash flow of such companies, further adding to the woes.

THE QUARTER GONE BY:
The September ’08 quarter was a reflection of these trends as India Inc’s profit growth came to a halt. The net profit reported by 1,214 listed companies grew by just 3% on a year-on-year (y-o-y) basis — the slowest profit growth in the past 10 quarters. We excluded banking and finance companies from our calculations due to the different revenue recognition practices they follow, as well as four public sector oil majors — IndianOil, Bharat Petroleum (BPCL), Hindustan Petroleum (HPCL) and ONGC — whose profits depend on government-determined subsidies and their large size can influence the aggregate numbers. A fall in the operating margin of the sample, which came down to a 20-quarter low of 15.6%, was not totally unexpected due to high inflationary pressures. When inflation soars, raw material costs and sales revenues move up in tandem; then the same operating profit, when calculated as a percentage to net sales, results in a lower operating margin. In fact, to remove this inflationary effect and to make historical data comparable, we have calculated various cost components as a percentage of operating profit, rather than net sales, in the adjacent chart.
Other income, which was fuelling India Inc’s profit growth towards the end of ’07, has failed to prop up profits in the September ’08 quarter. As a result, the y-o-y growth in PBDIT slipped to 10% from 16% in the June ’08 quarter and around 25% in FY08.

HURTING INTEREST:
A spurt in global interest rates was one of the major outcomes of the unprecedented global credit crisis. At the same time, the rupee lost heavily due to an exodus of foreign investments. Both these factors increased the interest burden for domestic companies, which rose a whopping 86% y-o-y. The interest costs alone took away over 16% of India Inc’s operating profits in Q2 FY09, which was substantially higher than 10% in FY08. Besides a rise in interest costs, an increase in the proportion of depreciation in operating profits indicate that various projects, launched earlier, have commenced operations in the quarter. The resultant pre-tax profit grew just 1.4%. However, a fall in the effective rate of tax propped up the net profit growth to 3% y-o-y. The effective rate of tax dipped to a two-year low of 22.8%.

NOT JUST LOSERS:
Industries such as cement, automobiles, consumer durables, pharmaceuticals and chemicals had a particularly bad quarter. Telecom, hospitality, healthcare and logistics sectors, which were doing well in the past couple of quarters despite the slowdown, have also taken a hit in the current quarter.

No Silver Lining
DESPITE THE odds, a few industries have done better than the others. These include the information technology (IT) sector, where a number of mid-sized companies recorded a healthy profit growth, thanks to a weaker rupee.
The sugar industry gained from higher sugar prices, while changes in the government’s subsidy norms helped fertiliser companies. Even the metals industry posted a double-digit profit growth, as the recent crash in prices had a limited impact in the September ’08 quarter. Healthy profit growth of biggies such as GE Shipping, Shipping Corporation of India (SCI) and Container Corporation (Concor) helped the logistics sector to report double-digit growth.
The profit growth of the FMCG sector, although in single-digit, was better than that in the preceding quarter. Although these industries did well during the September ’08 quarter, the likelihood of a continued outperformance is limited.

WHERE TO GO:
Although the Indian economy is less dependent on exports, it is linked to the global economy in more ways than one. The number of troubled industries is growing steadily from just textiles and real estate to airlines, brokerages, gems & jewellery and NBFCs, which have been in the news for cutting salaries or laying off employees. Other sectors such as hospitality, steel, cement, shipping and automobiles are also facing a slowdown.
Most of the companies in the above mentioned sectors have been expanding capacities over the past couple of years.
Although conditions are tough for everyone, there still remain a few industries where investors can expect some growth. The much-touted FMCG sector is one such investment avenue. The natural gas transmission industry is also likely to defy the difficulties and prosper, thanks to the rising availability of natural gas in India.
Similarly, companies offering services to onshore and offshore petroleum exploration activities are likely to grow, largely due to the existing long contracts they hold. Also, considering the power deficit in the country, turnkey contractors for power plants will continue to see healthy performance. Investing in stocks to earn dividends can also be a good approach, since a number of good companies are available at healthy dividend yields. However, a careful research of the companies is a must.

WHAT NEXT?
While India Inc’s profit growth has hit the bottom, the overall economic environment continues to deteriorate. For the time being, liquidity problems are being well-addressed, but the financial system globally is expected to suffer for some more time from the aftershocks of the subprime crisis.
At the same time, the options available with the Indian government to support economic growth appear limited, thanks to burgeoning trade and fiscal deficits. All this indicates prolonged pain in the months to come. If the current trend continues, India Inc can very well expect its December ’08 profits to slump below the December ’07 levels.

OMCs: Oil’s Well

DOMESTIC oil marketing companies (OMCs) — which together posted a net loss of over Rs 12,800 crore in the September ’08 quarter, despite almost equal amount of discounts from ONGC and over Rs 20,500 crore of oil bonds — are set to gain as crude prices have crashed. Crude prices on NYMEX fell to $61 per barrel by the second week of November — more than 58% lower than the high of $145 reached in July.
Prices have declined despite the 1.5 million barrels per day production cut implemented by Opec from November 1, as the economic downturn is reducing demand for transport fuels. Demand for gasoline in the US (the largest consumer of petroleum) has fallen so steeply, that refiners are now incurring losses on sale of gasoline. At the same time, China, which posted highest incremental growth in petroleum consumption last year, is also witnessing a slowdown in fuel demand.
In the September ’08 quarter, OMCs posted negative refining margins due to inventory losses, while the marketing operations continued to lose money. However, with crude prices stabilising around $60, the story will be different in the next quarter. The Indian basket of crude oil that represents a blend of Dubai/Oman and Brent crude in a 62:38 proportion, has fallen to the $56 level, at which, marketing of transport fuel has become profitable. With crude prices stabilising, OMCs’ refining operations will also turn positive. Given that government support and upstream discounts continue to take care of losses on LPG and kerosene, BPCL, HPCL and IOC can once again post healthy profits.

GREAT Offshore: Sailing In Choppy Seas

GREAT Offshore (GOL) recently completed the acquisition of 100% stake in two companies operating on India’s east coast — KEI RSOS Maritime and Rajamahendri Shipping & Oilfield Services — for Rs 160 crore. The company had announced this deal in early September. These companies are mainly into port management services, single-point mooring and offshore support.
This acquisition added 19 vessels (nine offshore support vessels and 10 harbour tugs) to GOL’s existing fleet of 41 vessels, with four more to join over the next six months. GOL itself has ordered a drilling rig and multi-support vessel to be delivered in March ’09 and September ’09, respectively, at a cost of $230 million. This acquisition is expected to add Rs 30-32 crore to GOL’s consolidated bottomline in FY10. Last year, GOL had raised around Rs 168 crore through foreign currency convertible bonds (FCCBs) and Rs 150 crore through preference shares, specifically for acquisition purposes. It was also planning to acquire a foreign company, but the deal did not fructify. The company recently spent Rs 55.2 crore on share buybacks at an average price of Rs 564. This reduced its share capital by around 2.6%, resulting in an increase in promoters' holding to 20.5%.
GOL’s results for the past couple of quarters have been dismal with a significant fall in profits, though it is the largest offshore support company in India in terms of fleet size. Over the past couple of years, the company has been trying to grow rapidly, which has resulted in cash outflow on investment activities, outstripping operating cash inflows. In view of the recent weakness in economic environment and the fall in crude oil prices, the company’s ability to secure high charter rates for its vessels remains crucial for future success. GOL faces the risk of a fall in charter rates in the offshore drilling industry by the time its two high-value vessels are delivered.

India’s 100 Fastest Growing Small Companies: Small Wonders

ETIG is back with the 2008 edition of India’s 100 Fastest Growing Small Companies...

"THE MARKETS are in turmoil” — the drama unfolding in the stock market makes this a gross understatement. Bloodbath is the only word that can aptly describe the mad rush to sell off shares faster than the clock ticks. The reasons are many and varied, and the fall has turned into a self-propelling snowball, which just keeps on gaining mass and speed on its way down the hill.

When the large-cap giants have been beaten out of shape and their valuations have turned cheap beyond imagination, it surely is not a good idea to talk about small companies. And one also has to be extremely careful while talking about ‘growth’, else retail investors will discard it as an extinct word. But growth is the only way listed companies generate wealth and value for their shareholders and other stakeholders, including employees. The younger and smaller the company, easier it is to grow. And the earlier you are able to pick future leaders, the better it is for you. In fact, during the last bear run, which ended in early 2003, many small companies gave double-digit annual returns on a consistent basis, even as frontline companies remained grounded.

It was for the above reasons that we decided to come out with our first list of India’s 100 fastest growing small companies in 2007. The list was highly appreciated by our readers. With the annual reports of most companies out now, we need to update this list. Here, we present the 2008 Edition Of ETIG’s 100 Fastest Growing Small Companies. Last year’s list was dominated by companies from the then hot sectors such as real estate, capital goods and construction, with a sprinkling of IT companies. In the past one year, there has been a dramatic shift in the Indian growth story and this is clearly visible in this year’s rankings. While investment-demand driven sectors such as capital goods, real estate and construction continue to be in the list, the toppers are now from less cyclical and asset-light sectors, especially infotech. This may surprise many readers as the IT sector has borne the brunt of the recent bloodbath in the stock market. Most IT companies are currently trading at less than half their market value a year ago due to market concerns over the slowdown in the industry’s growth. Many IT companies figure in the top quartile of this year’s list. A close study reveals that only a few of the companies in the list are typical IT companies. Most of the companies, including top-ranked ICSA, are new-age IT services providers which operate in their own niche with little competition. And unlike their frontline peers, these companies operate in the domestic market, which makes them immune to currency fluctuations. It won’t be an understatement to say that this is the new face of the Indian IT industry — companies offering niche product and services with a clear differentiating factor. ICSA, for instance, offers supervisory control and data acquisition (SCADA)-based IT solutions to power companies, while Allied Digital provides remote infrastructure management and systems integration in the domestic market. Info Edge (India), on the other hand, owns niche portals such as naukri.com and shaadi.com, while Tanla Solutions develops value-added solutions for mobile phones.

This just goes to prove that it is possible to grow in the toughest of economic environment. What is needed is a financially viable and scalable business model. The next challenge for these companies will be to further scale up their businesses in an environment which is getting excruciatingly difficult by the day.

HOW WE DID IT
It was only two weeks ago that we came out with the list of India Inc’s elite club — ET500 — representing India’s largest listed companies. In view of this, it was only logical that in order to find the fastest growing small companies, we exclude all companies that figured in ET500.
So, the largest company in our sample had net sales of around Rs 720 crore, while the minimum net sales figure was fixed at Rs 100 crore. The next filter was market capitalisation. We considered only those companies which figured in the bottom 20% of the cumulative market cap of all companies listed on the BSE. So, the most valuable companies in our sample had a market cap of Rs 2,500 crore (the average for September ’08) and we excluded companies with a market cap of less than Rs 100 crore. To weed out the weaker constituents, we added criteria such as return on capital employed (RoCE), debt-equity ratio (DER) and interest coverage ratio (ICR). As a result, the final list comprised financially sound companies, which had an average RoCE of over 15%, average DER below 1.5 and ICR of above 5, for the preceding three years. We could find only 106 companies which met all our criteria, or less than 5% of our initial sample of around 2,000 companies.
We calculated the compound average growth rate (CAGR) in sales and net profit for all these companies for the preceding three years. The final ranking was done by assigning a 30% weightage each to RoCE and ICR, while a 20% weightage was given to the three-year CAGR in sales and net profits. Basically, this means that while growth is key, the quality or the ways of achieving it are of greater importance. You are now free to take your pick. But keep in mind that the ranking is not an endorsement of these companies. Make your own assessment before investing in any of these stocks.

(To view the complete list of ETIG’s 100 fastest growing small companies, log on to www.etintelligence.com)

Lower subsidy lifts Gail’s bottomline

INDIA’S largest natural gas transporter posted a substantially better result for the quarter ended September 2008 helped by higher operating margins and flat subsidy burden. Gail net profit during the second quarter spurted 79% to Rs 1,023 crore while its net sales grew 36% to Rs 6,173 crore.

Gail’s operating margin in the quarter jumped 450 basis points to 23.9% mainly due to a sharp fall in its other expenditure. The company had booked Rs 257 crore in the corresponding quarter of the previous year as write-off on an exploration well going dry inflating the other expenditure. A fall in interest and depreciation costs and easing of effective rate of tax to 31.9% helped the company’s bottomline post a sharp growth. Liquid hydrocarbons proved to be the best performing segment for Gail as its subsidy burden inched up only marginally to Rs 401 crore. The profit of this segment jumped 157% to Rs 575 crore making it the largest contributor to Gail’s bottomline. Natural gas trading business as well reported a robust performance with 58% profit growth to Rs 111 crore. The profits from transmission of natural gas and LPG as well as the petrochemicals business remained flat.

Despite a weak market Gail shares ended 0.5% higher at Rs 224.65 on Thursday ahead of its results. The scrip has lost 19% against a 28% fall in Sensex over last one month.

Going forward, Gail is likely to emerge as the key beneficiary of improving natural gas availability in India. The company is laying up pipelines to double its transmission capacity in next three years. Additional natural gas from RIL’s KG basin and Petronet LNG’s expanded capacity is expected to start accruing from the first quarter of 2009 onwards.

RIL’s Q2 net may not lift sentiments

RELIANCE Industries — India’s largest company by market capitalisation and one of the most widely held stock — is unlikely to liven up the market when it announces its second-quarter result on Thursday. RIL’s profit for the quarter is expected to grow only marginally, or even dip, compared with the year-ago period.
“Reliance has come out with steady results in volatile markets. However, RIL will struggle to touch two-digit profit figure this quarter because of the slowdown in refining margins. On the other hand, improved margins in petrochemical business could result in flat growth in net profit,” said an analyst working with a leading international brokerage. The petroleum refining industry has entered a slowdown phase globally, with the gross refining margins (GRM) — the differential between prices of crude oil and refined products — coming down from the previous quarter. Motilal Oswal in its Q2 earnings preview report said, “During the quarter ended September 2008, Singapore GRM at $5.4/bbl was down 15% against $6.4/bbl in Q2FY08 and down 33% compared with $8.1/bbl in the immediately preceding quarter.”

As a result, RIL’s petroleum refining business, which contributes nearly twothird to its revenues, is likely to record a lacklustre performance in the latest quarter. Analyst estimates put RIL’s GRMs in the $11-$13 per barrel range, weaker from $15.7 posted in June 2008 quarter and $13.7 in September 2007 quarter. This means its refining profits will be lower on a year-on-year basis.

In contrast, RIL’s petrochemicals business is expected to post healthy revenues and improved margins due to stagnancy in feedstock naphtha prices. Petrochemicals represent around 30% of RIL’s revenues and profits. The smaller segment of oil and gas production is also likely to perform well due to higher petroleum prices in the September 2008 quarter compared with the previous year. Weakness in the rupee is another factor that will impact RIL’s performance. Despite being India’s largest exporter, RIL has always had more imports than exports. Particularly, a major chunk of its petrochemicals is sold domestically within India. However, since the domestic petrochemical prices are linked to their import parity prices, RIL is likely to benefit from the weak rupee. “We expect RIL’s petrochemical EBIT to rise 5% y-o-y to Rs 2,130 crore mainly driven by a weaker rupee,” mentioned a Merrill Lynch report.

Brokerage houses are divided on RIL’s profit growth this quarter. Among them, Angel Broking is the most bearish on RIL, projecting a 13% fall in its Q2 profits. As against this, Motilal Oswal and Sharekhan are the most bullish, estimating around 9% rise in RIL’s profit. The estimates of other brokerages like Prabhudas Leeladhar, Merrill Lynch, Citi Investment are somewhere in between. The company is expected to post good profits in the coming quarters because of sale of oil & gas from the KG basin.

SLIPPING FORTUNES Slowdown in refining margins likely to hit RIL’s Q2 bottomline Broking houses divided over RIL’s financial performance Angel Broking is bearish, while Motilal Oswal, Sharekhan keep a bullish view

Gail: Lots In The Pipeline

Gail is a low-risk investment option with immediate growth triggers. Its current valuations are attractive for long-term investors

EVEN AMIDST the current market uncertainty and financial turmoil, Gas Authority of India (Gail) stands out as a low-risk investment option with immediate growth triggers. We had recommended this stock in our edition dated March 17, ’08. Although the scrip has not lost much in the recent meltdown — declining around 10% since our recommendation, against a 32.6% fall in the Bombay Stock Exchange (BSE) Sensex — its current valuations are attractive for longterm investors. Gail enjoys a monopoly status and an inherent pricing power in cross-country natural gas transmission, as it owns India’s largest gas pipeline network. The fact that it is a government-owned, diversified and cash-rich company improves its risk profile. Reliance Industries’ (RIL) natural gas, which is expected to start flowing from the fourth quarter of FY09, will benefit Gail to a great extent. Natural gas is a cheaper and better alternative to liquid fuels and there is a huge unmet demand in India. As a result, the company will enjoy the twin benefits of sustainable growth, while keeping risks low, even in times of a global financial turmoil and economic slowdown.

BUSINESS:
Gail’s business model is well-diversified as it operates in the entire natural gas value chain from processing, transporting and marketing, to producing liquid hydrocarbons and downstream petrochemicals. It is going in for the last step in backward integration of producing natural gas and has invested in 29 exploration blocks and three coal bed methane (CBM) blocks.
As part of its diversification in natural gas-related businesses, it has invested in liquefied natural gas (LNG), gas-based power plants and gas retailing through city gas distribution (CGD) projects. Its wholly owned subsidiary, Gail Gas, is setting up a compressed natural gas (CNG) corridor on the country’s national highways.
The company is already connected with all the natural gas supply points — Dahej and Hazira in Gujarat, Uran in Maharashtra and now Kakinada in Andhra Pradesh. This makes it a natural transport partner for any large producer or consumer of natural gas. Gail is now laying pipelines on the west coast, which will connect future LNG terminals at Dabhol and Kochi to the national gas grid. In a bid to diversify geographically, the company has gone to countries like China and Mongolia to implement CGD projects. Gail produces liquefied petroleum gas (LPG) — one of the heavily subsidised petroleum products in India — and has to suffer a portion of the under-recovery. However, over the past couple of quarters, Gail’s subsidy burden has remained flat, despite the spurt in global oil prices, which is directly helping its liquid hydrocarbons business. We expect that even in future, Gail’s subsidy burden will remain at present levels, which will allow the company to post decent profit growth.

GROWTH DRIVERS:
At present, the company transports over 82 million metric standard cubic metres per day (mmscmd) of natural gas, produces 1.3 million tonnes (mt) of liquid hydrocarbons, including LPG, and nearly 4 lakh tonnes of polyethylene. The company has recently expanded its polyethylene capacity by 25% to 5 lakh tonnes, which will be gradually scaled up to 8 lakh tonnes.
Gail has embarked on an ambitious plan to invest over Rs 28,800 crore by ’12 to expand capacities in areas such as pipelines, exploration & production (E&P), petrochemicals, city gas projects, LNG etc. This entails doubling the natural gas transmission capacity, covering over 200 cities under CGD, 60% expansion of petrochemicals capacity and expanding LNG terminals.

FINANCIALS:
Since FY05, Gail’s net profit has witnessed a compound annual growth rate (CAGR) of 11.2%, while its sales grew 10.7%. In the quarter ended June ’08, the company posted 31% profit growth to Rs 897 crore, on the back of a 35% jump in sales to Rs 5,731 crore. The company’s LPG and liquid hydrocarbons business, which was making losses in FY07, has witnessed substantially superior profit margins in FY08; in the first quarter of this year, its profit margin touched nearly 40%. Similarly, the natural gas transmission business is showing a steady increase in profit margins. The company recently issued bonus shares in the ratio of 1:2. If the company maintains a 100% dividend policy, as in the past three consecutive years, its dividend yield will be a decent 4% at the current market price (CMP).

VALUATIONS:
At the CMP of Rs 243.65, the scrip is trading at a P/E multiple of 11. We expect the company to close FY09 with an earning per share (EPS) of Rs 26.1 and FY10 with an EPS of Rs 32.3. The CMP is 9.3 times the expected FY09 EPS and 7.5 times the expected FY10 earnings. At the same time, nearly 30% of Gail’s market capitalisation is represented by the value of its investments and cash. Hence, its core business is available at even cheaper valuations. Existing investors are advised to stay invested in the stock.

INDIA INC GOES GLOBAL

Indian economy has gone through a dramatic transformation in the last five years or so. And nowhere is this more visible than the boardrooms of India Inc. The high brow discussions on economic and business issues in board meetings has given way workshops on abstract topics such as integration, cultural fit and diversity management. What's more these discussions are often moderated by exexpat CEOs who are most likely to be affected by its outcome. Blame it on the new wave of globalisation that is sweeping through India Inc.
Though globalisation is now a cliché, this new wave is unlike any other. While in the past Indian companies participated in it as low-cost exporters, or say technology seekers or at best a local partner to MNCs, the same companies now found these strategies stifling. They are now breaking free to seek a place at the global high table. This is the new face of India Inc and we have captured in its full glory in the latest edition of ET500, which will hit the stands two days from now.
And we don't bring you just heaps of data and analyses. India's Inc top minds will be there to tell you the story of their globalisation drive, its strategic rational and the ways to make it successful. When talking about globalisation the first name that comes to mind is Tata Group. Their recent acquisitions -be it Corus or Jaguar Land Rover or General Chemicals-has put India on the global map.
So it was but natural for us to begin the journey the with an hour-long interview with Mr Alan Rosling, Tata Son's executive director and the brain behind the Group's globalisation drive. And we start from the ground zero, the genesis of the group's recent moves in the international market. If he is to be believed, Indian companies are better placed to make their overseas acquisitions successful. "Thanks to their unique history and culture, Indians find it easy to assimilate with new people and cultures. They don't usually force their way of life on others and this makes integration easier," says Mr Rosling. The softer issues play a key role in the success of an acquisition. And no one is better placed to flag the subject than Tata Group's HR head Mr Satish Pradhan, who is tackling this issue on everyday basis. Next we turn our attention to individual companies -Tata Chemicals and Tata Communications, to get their side of the story.
However globalisation fever is not limited to Bombay House only. One of the most talked about globalisation stories have been that of Avantha Group (formerly L M Thapar Group). Under the leadership of Mr Gautam Thapar, the group has transformed itself from a laggard to one of fastest growing and the most globalised of its peers. We caught up with Mr Thapar to get a first hand account of this journey. We followed it up by chatting with Mr Sudhir M Trehan, managing director of Crompton Greaves, the group's flagship company.
Globalisation is not only about having production facilities abroad, it also involves tapping global sources of finances and most importantly creating a global talent pool. We tackle the issues in two separate features.
Last year, we changed the ranking parameters to make its simpler and brought it in line with the globally accepted definition of size i.e revenues in last financial year. We have stuck to it and its amazing to see the resulting dynamism in ET500. Many companies made it the list this year thanks to IPOs. And as we found out some of most prominent of them are public sector undertakings, just another indicator of the rising presence of PSUs in India Inc. A long-term investor should keep a close watch on them.

Crude oil prices: On Slippery Terrain

The recent fall in crude oil prices will ease pressure on the government’s treasury, but refining companies are likely to take a hit. The future course of prices will depend on the global financial market turmoil to a large extent

THE RECENT unexpected fall in crude oil prices has followed the unprecedented financial sector crisis that the world is currently facing. As global liquidity dries up, there has been a blanket sell-off in various asset classes — crude being one of them. Although economic growth concerns have been weighing on demand for petroleum products, they surely do not seem sufficient enough to cause a nearly 45% fall in crude prices to below $80 per barrel, after hitting a peak in July.
Crude oil is the world’s most widely consumed commodity and any move in its prices has a global impact. One would assume that the sudden, steep fall in crude prices will bring cheer to the domestic petroleum industry, which has been reeling under heavy under-recoveries. However, the impact of this crash will vary for different participants, and will also differ in the short- and long term. A basic understanding of these forces and their inter-relationships is necessary for investors, so that they are able to make the right choice when the tide turns.

EFFECT ON INDIAN ECONOMY:
The fall in crude oil prices has come as a boon for the Indian economy, which is witnessing a very high level of inflation triggered by sky-high crude prices. Although crude price was one of the reasons for the sharp rise in India’s inflation, the recent steep fall is not likely to reflect immediately on the inflation numbers. Since the government and oil companies absorb a major portion of the burden, rather than passing it on to consumers, the fall in crude prices will first ease the country’s fiscal deficit and provide some relief to oil companies. The total under-recoveries, which were predicted to reach Rs 240,000 crore for FY09, may now be restricted to Rs 160,000 crore.

FOR PRODUCERS:
Normally, a fall in crude prices is bad news for oil producers, but this is not the case for India’s largest oil producer, ONGC. Since the company is a beneficiary of nominated oil blocks, it has to sell crude at a discounted price to public sector refining companies. Its net realisation stood at only $70 in the quarter ended June ’08, although global prices averaged around $126. The recent fall in crude price will only reduce ONGC’s discounts, while keeping its net realisations unchanged. Hence, the company, which had received $55.9 per barrel in the quarter ended September ’07, is likely to earn better returns in the second quarter of FY09, despite the fall in crude prices. And till crude price stays above the $70 level, its fluctuations will have little impact on ONGC’s earnings. However, for other relatively smaller players in the private sector, the normal rule will be applicable. Companies like Cairn India, Selan Exploration Technology, Hindustan Oil Exploration and Reliance Industries (RIL) will see a drop in their future realisations from production of crude oil.

FOR REFINERS:
Although crude oil is the raw material for petroleum refiners, movement in the price of crude alone does not affect them. What really matters is the differential in the price of crude oil and refined products. Refiners benefit if the fall in prices of petrol and diesel is less than the fall in crude oil prices. However, this logic holds in an ideal situation. In reality, there is a 30-day gap between the purchase of crude oil and selling of output. So, if the price at which crude oil was bought is higher than the price at which its refined products are sold, then refiners book inventory losses and vice-versa. Hence, the one-way fall in crude oil prices results in heavy losses for refiners in the particular quarter. The fall in crude prices has been so steep during the past three months that the entire refining margins for several refiners may be wiped off. Standalone refiners such as Mangalore Refinery & Petrochemicals (MRPL) and Chennai Petroleum (CPCL), as well as private sector players like RIL and Essar Oil, are all expected to witness a substantial fall in their refining margins. However, this scenario will rectify itself in the next quarter, once crude prices stabilise.

FOR MARKETERS:
For oil marketing companies (OMCs) — which sell refined products in the retail market — the fall in crude prices does not mean much. Firstly, since their purchases are dollar-denominated and sales are rupee-denominated, the rupee’s depreciation takes away a chunk of the benefits they would otherwise have enjoyed from a fall in crude prices. The rupee has lost nearly 14% in the past three months and is hovering around 48.4 versus the dollar, making imports costlier.
Secondly, OMCs’ refining operations, which would otherwise absorb a part of their marketing losses, will witness heavy erosion in profits. As a result, their profitability will continue to depend on the amount of oil bonds issued by the government. Going forward, even if these companies are able to trim their losses, the same will be reflected in a fall in oil bonds issued to them by the government.

FOR EXPLORATION SUPPORT INDUSTRY:
There are a host of companies which offer various services to oil majors in exploration and production. With crude prices rising steadily, exploration activity across the world has increased substantially, boosting demand for the services and assets offered by such companies. These include exploration support companies such as Aban Offshore, Great Offshore, Jindal Drilling, Shiv-Vani Oil & Gas and Dolphin Offshore. However, this industry mainly operates on long-term contracts, which range from six months to five years. At the same time, petroleum exploration is a lengthy activity — it usually takes several months, if not years, to determine the presence of hydrocarbon reserves, as well as their commerciality. Hence, the sudden slump in crude prices is unlikely to have any immediate impact on the players in this field. Going forward, if crude prices continue to stay around the present levels for a prolonged period — say, more than a year — then these companies may witness some impact on their order flow.

SUMMING UP:
Just like any other sharp and secular movement, the recent fall in crude oil prices has brought its own set of problems. On the one hand, it is easing pressure on the government’s treasury, but on the other hand, refining companies are set to take a hit. Globally, the balance between demand and supply of crude oil will continue in the months to come. The future course of crude prices will depend on the global financial market turmoil to a large extent. In the medium term, crude prices are expected to stay range-bound near current levels.

From moving in a fairly stable range over the past three years, the rupee suddenly finds itself swerving around in a rather rocky terrain.

From moving in a fairly stable range over the past three years, the rupee suddenly finds itself swerving around in a rather rocky terrain. Ramkrishna Kashelkar takes a hard look at the grim scenario

WHEN THE rupee was appreciating last year, it was widely believed that the upturn was here to stay. Foreign investments came rushing to India, lured by its strong economic growth and low inflation. Even Indian corporates went overseas like never before, borrowing heavily to fund acquisitions, as well as various expansion projects. So, when the tide turned, it was a rude awakening for India Inc. Today, India is more integrated with the global economy compared to a decade ago and the rupeedollar exchange rate has a huge bearing on India Inc’s growth prospects.
India continues to be a net importer of goods, especially capital goods and key industrial inputs. A costlier rupee raises project costs and affects the rate of investment, which impacts economic growth. Besides, depreciation in the rupee reduces the financial returns of foreign investors, reducing the relative attractiveness of India as an investment destination. Given this, if we want to have a view on India’s growth story, it becomes necessary to understand the moves being made by the rupee. Why the rupee depreciated suddenly is an interesting question. The most obvious reason is the global financial crisis and the ensuing massive unwinding of foreign portfolio investors to fund their domestic liquidity requirements. However, there have been subtle changes in the economy over the past few months that have been hinting at a weak rupee.
India’s inflation spurted to double digits in June ’08 — higher than the rate of economic growth — on the back of high crude oil and commodity prices. At the same time, the government’s decisions to raise subsidies rather than pass on the high global prices of crude oil and fertilisers have dramatically increased the fiscal deficit. Besides, the government has to make provisions for waiving agricultural loans, handing out the Sixth Pay Commission awards and other welfare schemes launched in the recent past. According to various estimates, these measures are expected to push India’s fiscal deficit to nearly 8% of the gross domestic product (GDP) — the highest ever in nearly a decade. A bigger fiscal deficit translates into an equally huge trade deficit, which puts downward pressure on the rupee. Till such a time these worries are addressed extensively, the downward pressure on the rupee is likely to continue.

US AND THEM
It is not just the rupee, which has taken a thrashing from the sudden exit of foreign capital. Other emerging markets such as Brazil and Russia have also witnessed a depreciation in their currencies — sharper than India’s — over the past few weeks. While the rupee lost around 7.5% of its value from the beginning of July ’08, Brazilian real lost 20.6%, Russian rouble fell 10.3% and South Korean won depreciated by 16.9%. China is the only country whose currency has appreciated against the dollar over a period of time.

THE SLIPPERY ZONE
While the outflow of the so-called ‘hot money’ has hit the rupee hard, the continuing liquidity problems overseas are adding fuel to it. The foreign branches of Indian banks are suddenly finding it difficult to roll over short-term loans taken from local banks. In such cases, they are left with no other option, but to raise the necessary foreign exchange (forex) in the domestic market by selling rupees, which adds to depreciation in the rupee.

LIQUIDITY WOES
The Reserve Bank of India (RBI), which overseas the domestic money supply, also monitors the supply of forex in India, so as to smoothen out the erratic movements by keeping the markets wellsupplied and liquid.
However, RBI’s ability to intervene in the market is limited. The level of RBI’s forex reserves, which were on a secular uptrend till May ’08 to reach $315 billion, have been waning since then. Current forex reserves of $292 billion indicate a 7.3% drawdown from the peak, but they are still at very high levels, considering India’s history of having reserves equivalent to around 12 months of imports.
But forex reserves have to be used carefully because they play a key role in maintaining the general confidence in the currency. The structure of India’s foreign capital inflows has changed dramatically in the past few years. While India’s total capital inflows have increased at a compounded annual growth rate (CAGR) of 58.4% over the past five years, the hot money inflow — capital coming in through portfolio investments and short-term credit — has grown at 89%.

A HAZY FUTURE
DURING FY08 alone, nearly $46.8 billion of hot money flowed into India, representing 43.3% of India’s net capital inflows of $108 billion. Since hot money can be easily pulled out at short notice, its large presence in the economy is a potential danger. The boom in the economy and the stock market in earlier years led to its rising influence. But with things not so smooth any more, it increases the risk of a sudden exodus of foreign capital. Similarly, at times, RBI’s ability to intervene in the forex market gets restricted due to liquidity problems. When the rupee is being sold off and losing value, RBI needs to sell dollars to support the rupee. This reduces liquidity in the banking system. So, it needs to be careful that its forex market operations do not leave the domestic financial system dry. Non-food credit growth has reached 25% despite high interest rates due to heavy borrowings by oil and fertiliser companies. RBI has taken steps to address liquidity problems. It started a second daily liquidity adjustment facility for banks and also allowed them to dip below the mandated 25% statutory liquidity ratio requirement by one percentage point. In a bid to attract more foreign currency, RBI has hiked interest rates on foreign currency deposits by 50 bps.

MACRO MIX-UPS:
The Indian economy is not in good shape. Growth in IIP has slowed, while inflation has soared. During the first five months of FY09, fiscal deficit has already crossed 87% of India’s full-year forecast. The spurt in global crude prices has single-handedly increased India’s trade deficit. Crude prices jumped to an average of $120 in the first half of FY09 from $70 in the corresponding period of previous year. So, India’s oil import bill swelled 77% in August ’08 to $11 billion and by 60% to $46 billion during April-August ’08. In view of this, India’s export growth is falling short of the growth in imports. The resultant trade deficit is likely to touch $125 billion for the whole of FY09. There appears some light at the end of the tunnel on this count. Crude prices have retraced nearly one-third from their peaks to fall below $100 per barrel and are expected to remain range-bound. In the medium term, domestic availability of natural gas and crude oil is expected to increase substantially as RIL’s oil fields in Krishna Godavari basin and Cairn’s Rajasthan fields begin production. Both these factors will ease India’s crude import bill and reduce the fiscal deficit. A simultaneous meltdown in the commodity market will also alleviate inflation.

NO CLEAR VIEW, YET:
The recent fall in the rupee, led by withdrawal of foreign portfolio investors from India, may not be rectified till stability returns. The global scenario is uncertain. India also needs to fight its own woes — high inflation, widening current account and fiscal deficits and slowing economic growth — besides absorbing repercussions of the global turmoil. The Indian economy’s ability to re-emerge as an attractive investment destination will determine the rupee’s upward movement. Till then, the rupee is likely to remain under pressure.