Praj Industries: The Perfect Blend

Praj Industries is in an expansion mode and has a healthy order book position. The stock appears attractive for long-term investors

THE CURRENT market meltdown has drastically reduced the valuations of several companies. However, in quite a few cases, the market has been too harsh on companies which have a promising future. This has created an excellent opportunity for long-term investors. One such company is Praj Industries, which has long been the market’s darling, due to its growth prospects in the ethanol industry.

The company has lost over half its market capitalisation in the past two months, without any corresponding change in its fundamentals or future outlook. Given that the company is in an expansion mode and is sitting on a healthy order book, it is expected to post a good performance next year. Long-term investors can consider the stock at current levels.

BUSINESS:
Pune-based Praj Industries is an engineering company and is the market leader in ethanol technology. It provides turnkey project implementation services to set up ethanol distillation units. The company has developed technologies to produce ethanol from a variety of feedstock such as sugarcane, sweet sorghum, corn etc and is trying to develop a commercially viable method to convert cellulose into ethanol. Besides ethanol — which accounts for over 80% of its revenues — the company also carries out distillation for breweries and plans to enter the bio-diesel space.

Praj has executed projects in over 35 countries. Over the past couple of years, it has taken steps to strengthen its global presence. These include an acquisition in the US and tie-ups with foreign companies in Europe and Brazil. With this, the company has established its presence in key markets across the world.

Over the past couple of years, the company’s shareholding pattern has witnessed a peculiar trend. The shareholding of the promoters and public has fallen, while institutional holding is on the rise. This indicates that the company is gradually becoming a professionally-dominated organisation, from a promoter-driven one. This augurs well for the long-term growth sustainability of its business model. Some of the most successful companies such as Larsen & Toubro,
ITC, HDFC and Infosys are majority owned by institutions.

GROWTH DRIVERS:
Ethanol and bio-diesel are gaining acceptance worldwide as eco-friendly fuels. Ethanol blending has already become mandatory for petrol in a number of countries, including its largest consumer, the US. The proportion of blending is slated to go up, with governments in the US and India mandating 10% blending over the next 2-4 years. The European Union is also contemplating to replace 10% of petrol consumed with ethanol. This is likely to create strong demand for turnkey solutions providers such as Praj Industries. The company already has an order book of Rs 900 crore, which will be executed over the next 12 months.

Praj is gearing up to cater to the fastpaced growth in future by expanding its capabilities. It has increased its manpower and set up its second manufacturing unit at Kandla SEZ. It has also established a full-fledged research centre for bio-fuels to develop new technologies in this field.

FINANCIALS:
Praj’s net profit has witnessed a cumulative annual growth rate (CAGR) of 43.2% over the past 10 years, while its net sales have grown by 27.3%. Although its dividend per share has increased over the past four years, dividend payout ratio has fallen, thanks to rapid spurt in net profit. The company has already disbursed 33% of its reported book profits for April-December ’07 via interim dividends.

Praj’s performance during the quarter ended December ’07 was lacklustre as it is in an investment phase currently. Its profit grew by 17.2% to Rs 39.4 crore, while net sales rose by just 1.3% to Rs 180.2 crore. But employee costs and other expenses rose significantly.

VALUATIONS:
At the current market price of Rs 132.10, the scrip is trading at a price-to-earnings multiple (P/E) of 19.8 based on its earnings in the past 12 months, which is nearly half its P/E just a couple of months ago. Considering Praj’s current order book, ability to win new orders and investment in research & development, we expect the company to maintain its EBIDTA margins above 20%. For FY09, we expect Praj to report earnings per share (EPS) of Rs 10.1. This discounts the current market price by 13.1 times, which appears attractive for long-term investors.

RISKS:
Despite staying debt-free, the company has expanded its equity capital on several occasions to raise funds. This has resulted in dilution of earnings. If this trend continues in future, it will be detrimental to the interest of retail investors.

Kiri Dyes and Chemicals: Simply Colourful

Kiri Dyes and Chemicals appears to be a good investment bet, considering its growth prospects from backward integration

COMPANY: KIRI DYES AND CHEMICALS

ISSUE SIZE: Rs 46.88-56.25

CRORE PRICE BAND: Rs 125-150

DATE: MARCH 25-APRIL 2, ’08

KIRI DYES and Chemicals (KDCL) is a Gujarat-based manufacturer of dyes and dye intermediates and caters to textiles, leather, paint and printing ink industries. It has a total production capacity of 10,800 tonnes per annum (tpa). It’s coming out with an initial public offering (IPO) to fund its proposed backward integration project to produce raw materials. Post-expansion, the share of chemicals and intermediates will go up in KDCL’s total revenues vis-à-vis revenues from dyestuff.

BUSINESS:
KDCL mainly manufactures reactive dyes, which are used in cotton-based fabrics and represent the single largest dyestuff produced globally, accounting for over 25% of total production. It operates four manufacturing units — three in Ahmedabad, which manufacture dyestuff, and one in Vadodara, which produces intermediates.

KDCL was traditionally a dyes manufacturer, but started manufacturing intermediates such as vinyl sulphone and H-acid in FY07. These intermediates accounted for a quarter of its total revenues in the first half of FY08. Nearly half of its turnover comes from exports, with Turkey, Korea, the US and Bangladesh accounting for two-thirds of its total exports turnover. To facilitate exports, KDCL has converted one of its Ahmedabad units into an export-oriented one, which enjoys tax exemption on export income till FY10. InNovember ’07, KDCL entered into a 40:60 JV with Zhejiang Lonsen Company to manufacture all types of dyes. Under the JV, a 20,000-tpa plant will be set up in India, which is scheduled to begin commercial production by end-’08.

The growth in the $23-billion global market for dyes, pigments and dye intermediates, has slowed down and is expected to hover around 2% over the next decade. This has increased competition in the industry and eroded its pricing power. India leads the production of reactive dyes in Asia. It currently exports nearly Rs 3,500 crore of dyestuff, 60% of which is contributed by dyes.

EXPANSION PLANS:
KDCL proposes to set up a 180,000-tpa greenfield intermediate chemical plant and a 2.9-mw co-generation power plant at Vadodara at a capital cost of Rs 43.8 crore. This will help it to secure raw materials at a reasonable cost, besides providing it with another source of revenue.

FINANCIALS:
For the half-year ended September ’07 (H1 FY08), KDCL reported a net profit of Rs 8.9 crore and revenue of Rs 97 crore. Between FY03 and FY07, its profit witnessed a CAGR of 20.8%, against a revenue growth of 10%. It has consistently improved its operating margins over the past few years, which stood at 15.8% during H1 FY08. Its debt-equity ratio fell to 1.31 on September 30, ’07 from 1.76 as on March 31, ’07. Its operating cash flows also turned positive during H1 FY08 after staying negative for a couple of years. This was due to a substantial fall in its debtors, coupled with rise in current liabilities.

VALUATIONS:
We expect KDCL to report an EPS of Rs 11.9 for the year ending March ’08 on post-issue equity of Rs 15 crore. Based on current market conditions and the company’s expansion plans, the forward EPS for FY09 and FY10 is 16.3 and Rs 21, respectively. At the lower and upper price bands, the P/E works out to Rs 7.6 and Rs 9.2, respectively, based on FY09 expected EPS. KDCL issued 12.5 lakh equity shares to pre-IPO investors at an average price of Rs 115.5. Considering this and the proposed IPO, the promoters’ holding will come down to 66.57%. Thanks to the current market meltdown, a number of comparable dyestuff and chemical companies are available at cheap valuations. For example, Atul is trading at a P/E of 6.8, Aarti Industries at 6.4, Bodal Chemicals at 4.1 and Metrochem Industries at 13.3. KDCL is currently passing through a phase of high growth and hence, its valuations appear reasonable.

The End May Be Over

The stock market appears to have neared its bottom and further downside looks limited. Though the situation remains volatile, most of the current indicators are pointing towards stability. The long-term outlook appears clouded, but with a positive undertone. India Inc’s Q4 results will give a clear picture as to what lies ahead

SUDDENLY, WHEN everything appeared to be going smooth, the stock market hit a speed breaker. As the problems in the US economy, led by the collapse of its housing industry and the subprime crisis, spiralled out of control, the investor community, globally panicked. The weakness in the stock markets worsened with large financial institutions selling off their stock market portfolios across the globe to meet the liquidity crisis. Once the fall began, it snowballed to gargantuan proportions, with most listed companies in the domestic stock market losing between 30% and 50% of their market capitalisation in the space of two months.

The downward journey of the stock market was accompanied by daily doses of bad news. The bears used every piece of negative information to hammer down stock prices. Before they could realise and react, retail investors were left with heavily depreciated portfolios.

However, we at ETIG, believe that the time has come to stop despairing and do a reality check. To assess and take stock of the situation, we carefully examined five factors that are most important for stock markets, namely, the economic outlook, global currency movements, India Inc’s quarterly performance, current market valuations and the Sensex’s technical overview. We believe that the five parameters determine the market’s movement in the long term. Our analysis reveals that the market seems to have reached its bottom, but some short-term volatility cannot be ruled out. Thus, longterm investors may find excellent opportunities to enter the market over the next few days. The others may consider entering once definite signs of recovery are visible.

MACRO SIGNALS
It’s true that in the case of a slowdown in the US, India’s exports to that country can go down. However, just around 14% of India’s exports are sent to the US, which means that the direct impact may not be that severe. On the contrary, it is believed that if US companies start facing the heat, they may be forced to outsource more to low-cost destinations such as India. This will increase India’s service and manufacturing exports to the US and improve the growth prospects of Indian companies in sectors such as IT&ITeS services, textiles and auto components.

Apart from problems emanating from the US, India still has its own worries. During ’07, the domestic manufacturing industry witnessed a slight, but persistent slowdown in growth to just 8.4% for the quarter ended December ’07, which further slowed down to 5.2% in January ’08. The performance of six core infrastructure industries decelerated sharply in January ’08, recording 4.2% growth, against 8.3% during January ’07. Fortunately, however, the services industry that contributes to more than half of India’s GDP continues to grow at over 10% yearon-year. The growth in the services industry is expected to push India’s GDP growth to 8.7% during FY08.

Going forward, the Indian economy and India Inc are also likely to get a boost from huge capital expenditure currently under implementation across manufacturing and infrastructure sector. Recent data from the Centre for Monitoring Indian Economy (CMIE) reveals that the total investment under implementation has grown to over $630 billion in the quarter ended December ’07, nearly 50% higher compared to $425 billion during the quarter ended June ’06. Even if just half of these projects get completed over the next three years, it will nearly double India Inc’s current asset base of $300 billion.

Considering India Inc’s current revenueto-assets ratio of 1.8, this additional investment can generate recurring annual revenues of over $500 billion for Indian companies. And if we assume that even around half of these revenues come to the listed players with their PAT-to-sales ratio remaining intact, their revenues and net profit will expand by around 60% and 50%, respectively.

Hence, this trend of rising investments, which hint at expansion of the economy, can be heartening. But a slowdown in the growth of imports of capital goods contradicts this view. The imports of capital goods registered an 18% growth in the April-October ’07 period, against a 48% jump recorded in the corresponding period of the last year. The domestic production of capital goods, however, continues to grow strongly.

But with high crude oil and food prices, inflation can be another major problem for the Indian economy. After staying at around 4% level for 25 consecutive weeks, inflation has risen steadily above 5.92% for the week ended March 8, ’08. The government is trying hard to control inflation with a variety of subsidies and proposed a 2% cut in excise duty across the board in the recent Budget. However, such measures will put pressure on the government’s exchequer and worsen fiscal deficit, thus resulting in higher inflation later.

CRUMPLING DOLLAR
Currency movements hold the key to fund flows across nations and can influence the stock markets strongly. As a direct result of the weakening US economic growth, the dollar has weakened substantially against global currencies over the past few months. Over the past 12 months, the US dollar has lost over 18% against major international currencies such as the Japanese yen and euro, while it has depreciated around 4% against the pound sterling and 8% against the Indian rupee. With the US Federal Reserve cutting interest rates relentlessly, the dollar’s position against its peers can deteriorate further in future. As the interest rate gap widens, logically, dollar investments should start flowing into emerging markets, which has not happened so far. However, as and when the uncertainty ends and the market comes out of the crisis engulfing the global financial institutions, foreign investors are likely to return to the equity markets.

THE MAGIC OF NUMBERS
But India Inc’s quarterly results will be the single most important specific indicator of the stock market’s performance over the next few months. Over the past few quarters, Corporate India has reported deceleration in earnings growth, which is worrying market participants. Worse still, bottomline growth is being increasingly fuelled by growth in the other income, rather than operating income. While the operating profit margin on an aggregate level appears intact, sales growth has visibly slowed down. For example, the set of companies, which reported a year-on-year (y-o-y) earnings growth of 31.6% in December, has recorded a y-o-y growth of just 16.4% in the December ’07 quarter.

How the future plays out will depend on India Inc’s results for the March quarter (Q4 FY08) over the next couple of months. And if the corporate advance tax figures are any indication, the tone appears robust. The advance tax payments for Q4 FY08 have jumped 110% compared to last year, indicating better corporate results than what the current sentiment indicates.

The market has so far been wary of unpleasant surprises in Q4 results, fearing that companies may report heavy losses from treasury operations. The fears were fuelled by two major instances — firstly, when ICICI Bank reported its $263-million markto-market losses to its portfolio, and secondly, when L&T acknowledged a potential Rs 200-crore loss on hedging transactions, or nearly 10% its estimated FY08 net profit. The advance tax payments of both these companies have doubled during the current quarter, which should put investors’ worries to rest.

WORTHY OF YOUR ATTENTION
The current meltdown has eroded nearly 29% of market capitalisation since January 11, ’08, resulting in more sober levels in the valuation. The Sensex is currently trading at a price-toearnings multiple (P/E) of 19.5, substantially down from 28.4 in January. Compared to this, the benchmark index of China, Shanghai Composite, is trading at a P/E of above 33.

The latest estimates from the International Monetary Fund (IMF) put China’s growth in ’08 at 10%. Against this, the most conservative estimates of India’s growth this year expect the economy to expand by 7%. If we work out the forward P/Eto-growth (PEG) ratio after factoring in these expected growth rates, the Sensex with a PEG of 2.7 appears more attractive against 3.3 for the Shanghai Composite.

We can also look at the valuation issue from another angle. Analysts expect the Sensex to close FY08 with an EPS of Rs 820-830, which is projected to grow over 15% in FY09 and cross Rs 950. At the current level, the Sensex is discounting this forward expected EPS for the next year at 15.8, which is substantially below its average P/E of 18.2 since ’00. This indicates that fundamentally, the stock market has neared its bottom and further downside is limited.
GETTING TECHNO
While we have considered fundamental factors, it will certainly help to take a look at the technicals of the Sensex. The technical analysis depends heavily on past trends in the market movement to predict its future trajectory.

The current bull run in Indian equities started in the summer of ’03 from a Sensex level of just under 3000. In the past five years, we have seen four meaningful corrections.

The first one took place in May ’04, post the debacle of the NDA government at the Centre; the second one occurred in May-June ’06; the third one in early ’07 and finally, the current one.

However, during all the previous three corrections, the lows that the Sensex made were deeper than the lows it had made during the previous corrections. At the same time, after making deeper lows, it went on to make a higher top.

In the last significant correction that we saw in early ’07, the Sensex had made a bottom at around 12300. So, as long as that is not violated during the current crisis, we can still consider the current fall as just a correction in the bull market and expect to see a bounce-back.

At the same time, a point to be noted is the similarity between the current correction and that of May-June ’06. In ’06, the Sensex lost 30% of its value from a high of 12671 in May to a low of 8799 in June.

Similarly, from the intra-day high of 20206 in January to a low of 14677 last week, the Sensex has lost a similar 30% of its value. So, if last week’s lows are not violated, the bottom may just be in place.

While we try to take a stock of the situation, it remains dynamic and ever changing. Most of the current indicators are pointing towards stability. The short-term risk appears to be minimal and the long-term outlook appears clouded, but with a positive undertone.

The quarterly results from April onwards will give a clearer picture about where India Inc stands. At the same time, changes in the economic data in India and more particularly, the US, should also be tracked to get a better view of things. For those investors who have faith in India’s long-term growth story, the next few days may be a good time to enter the market.

The End May Be Over

The stock market appears to have neared its bottom and further downside looks limited. Though the situation remains volatile, most of the current indicators are pointing towards stability. The long-term outlook appears clouded, but with a positive undertone. India Inc’s Q4 results will give a clear picture as to what lies ahead...
ramkrishna kashelkar

SUDDENLY, WHEN everything appeared to be going smooth, the stock market hit a speed breaker. As the problems in the US economy, led by the collapse of its housing industry and the subprime crisis, spiralled out of control, the investor community, globally panicked. The weakness in the stock markets worsened with large financial institutions selling off their stock market portfolios across the globe to meet the liquidity crisis. Once the fall began, it snowballed to gargantuan proportions, with most listed companies in the domestic stock market losing between 30% and 50% of their market capitalisation in the space of two months.

The downward journey of the stock market was accompanied by daily doses of bad news. The bears used every piece of negative information to hammer down stock prices. Before they could realise and react, retail investors were left with heavily depreciated portfolios.
However, we at ETIG, believe that the time has come to stop despairing and do a reality check. To assess and take stock of the situation, we carefully examined five factors that are most important for stock markets, namely, the economic outlook, global currency movements, India Inc’s quarterly performance, current market valuations and the Sensex’s technical overview. We believe that the five parameters determine the market’s movement in the long term. Our analysis reveals that the market seems to have reached its bottom, but some short-term volatility cannot be ruled out. Thus, long-term investors may find excellent opportunities to enter the market over the next few days. The others may consider entering once definite signs of recovery are visible.

MACRO SIGNALS
It’s true that in the case of a slowdown in the US, India’s exports to that country can go down. However, just around 14% of India’s exports are sent to the US, which means that the direct impact may not be that severe. On the contrary, it is believed that if US companies start facing the heat, they may be forced to outsource more to low-cost destinations such as India. This will increase India’s service and manufacturing exports to the US and improve the growth prospects of Indian companies in sectors such as IT&ITeS services, textiles and auto components.
Apart from problems emanating from the US, India still has its own worries. During ’07, the domestic manufacturing industry witnessed a slight, but persistent slowdown in growth to just 8.4% for the quarter ended December ’07, which further slowed down to 5.2% in January ’08. The performance of six core infrastructure industries decelerated sharply in January ’08, recording 4.2% growth, against 8.3% during January ’07. Fortunately, however, the services industry that contributes to more than half of India’s GDP continues to grow at over 10% year-on-year. The growth in the services industry is expected to push India’s GDP growth to 8.7% during FY08.
Going forward, the Indian economy and India Inc are also likely to get a boost from huge capital expenditure currently under implementation across manufacturing and infrastructure sector. Recent data from the Centre for Monitoring Indian Economy (CMIE) reveals that the total investment under implementation has grown to over $630 billion in the quarter ended December ’07, nearly 50% higher compared to $425 billion during the quarter ended June ’06. Even if just half of these projects get completed over the next three years, it will nearly double India Inc’s current asset base of $300 billion.
Considering India Inc’s current revenue-to-assets ratio of 1.8, this additional investment can generate recurring annual revenues of over $500 billion for Indian companies. And if we assume that even around half of these revenues come to the listed players with their PAT-tosales ratio remaining intact, their revenues and net profit will expand by around 60% and 50%, respectively.
Hence, this trend of rising investments, which hint at expansion of the economy, can be heartening. But a slowdown in the growth of imports of capital goods contradicts this view. The imports of capital goods registered an 18% growth in the April-October ’07 period, against a 48% jump recorded in the corresponding period of the last year. The domestic production of capital goods, however, continues to grow strongly.
But with high crude oil and food prices, inflation can be another major problem for the Indian economy. After staying at around 4% level for 25 consecutive weeks, inflation has risen steadily above 5.92% for the week ended March 8, ’08. The government is trying hard to control inflation with a variety of subsidies and proposed a 2% cut in excise duty across the board in the recent Budget. However, such measures will put pressure on the government’s exchequer and worsen fiscal deficit, thus resulting in higher inflation later. CRUMPLING DOLLAR
Currency movements hold the key to fund flows across nations and can influence the stock markets strongly. As a direct result of the weakening US economic growth, the dollar has weakened substantially against global currencies over the past few months. Over the past 12 months, the US dollar has lost over 18% against major international currencies such as the Japanese yen and euro, while it has depreciated around 4% against the pound sterling and 8% against the Indian rupee. With the US Federal Reserve cutting interest rates relentlessly, the dollar’s position against its peers can deteriorate further in future. As the interest rate gap widens, logically, dollar investments should start flowing into emerging markets, which has not happened so far. However, as and when the uncertainty ends and the market comes out of the crisis engulfing the global financial institutions, foreign investors are likely to return to the equity markets.

THE MAGIC OF NUMBERS
But India Inc’s quarterly results will be the single most important specific indicator of the stock market’s performance over the next few months. Over the past few quarters, Corporate India has reported deceleration in earnings growth, which is worrying market participants. Worse still, bottomline growth is being increasingly fuelled by growth in the other income, rather than operating income. While the operating profit margin on an aggregate level appears intact, sales growth has visibly slowed down. For example, the set of companies, which reported a year-on-year (y-o-y) earnings growth of 31.6% in December, has recorded a y-o-y growth of just 16.4% in the December ’07 quarter.
How the future plays out will depend on India Inc’s results for the March quarter (Q4 FY08) over the next couple of months. And if the corporate advance tax figures are any indication, the tone appears robust. The advance tax payments for Q4 FY08 have jumped 110% compared to last year, indicating better corporate results than what the current sentiment indicates.
The market has so far been wary of unpleasant surprises in Q4 results, fearing that companies may report heavy losses from treasury operations. The fears were fuelled by two major instances — firstly, when ICICI Bank reported its $263-million markto-market losses to its portfolio, and secondly, when L&T acknowledged a potential Rs 200-crore loss on hedging transactions, or nearly 10% its estimated FY08 net profit. The advance tax payments of both these companies have doubled during the current quarter, which should put investors’ worries to rest.

WORTHY OF YOUR ATTENTION
The current meltdown has eroded nearly 29% of market capitalisation since January 11, ’08, resulting in more sober levels in the valuation. The Sensex is currently trading at a price-toearnings multiple (P/E) of 19.5, substantially down from 28.4 in January. Compared to this, the benchmark index of China, Shanghai Composite, is trading at a P/E of above 33.
The latest estimates from the International Monetary Fund (IMF) put China’s growth in ’08 at 10%. Against this, the most conservative estimates of India’s growth this year expect the economy to expand by 7%. If we work out the forward P/Eto-growth (PEG) ratio after factoring in these expected growth rates, the Sensex with a PEG of 2.7 appears more attractive against 3.3 for the Shanghai Composite.
We can also look at the valuation issue from another angle. Analysts expect the Sensex to close FY08 with an EPS of Rs 820-830, which is projected to grow over 15% in FY09 and cross Rs 950. At the current level, the Sensex is discounting this forward expected EPS for the next year at 15.8, which is substantially below its average P/E of 18.2 since ’00. This indicates that fundamentally, the stock market has neared its bottom and further downside is limited.

GETTING TECHNO
While we have considered fundamental factors, it will certainly help to take a look at the technicals of the Sensex. The technical analysis depends heavily on past trends in the market movement to predict its future trajectory.
The current bull run in Indian equities started in the summer of ’03 from a Sensex level of just under 3000. In the past five years, we have seen four meaningful corrections.
The first one took place in May ’04, post the debacle of the NDA government at the Centre; the second one occurred in May-June ’06; the third one in early ’07 and finally, the current one.
However, during all the previous three corrections, the lows that the Sensex made were deeper than the lows it had made during the previous corrections. At the same time, after making deeper lows, it went on to make a higher top.
In the last significant correction that we saw in early ’07, the Sensex had made a bottom at around 12300. So, as long as that is not violated during the current crisis, we can still consider the current fall as just a correction in the bull market and expect to see a bounce-back.
At the same time, a point to be noted is the similarity between the current correction and that of May-June ’06. In ’06, the Sensex lost 30% of its value from a high of 12671 in May to a low of 8799 in June.
Similarly, from the intra-day high of 20206 in January to a low of 14677 last week, the Sensex has lost a similar 30% of its value. So, if last week’s lows are not violated, the bottom may just be in place.
While we try to take a stock of the situation, it remains dynamic and ever changing. Most of the current indicators are pointing towards stability. The short-term risk appears to be minimal and the long-term outlook appears clouded, but with a positive undertone.
The quarterly results from April onwards will give a clearer picture about where India Inc stands. At the same time, changes in the economic data in India and more particularly, the US, should also be tracked to get a better view of things. For those investors who have faith in India’s long-term growth story, the next few days may be a good time to enter the market.

You may feel heat of oil flares soon

THOUGH crude oil has begun to hit new highs with unfailing regularity over the past two months, the rise has not begun to upset our monthly budget thanks largely to government subsidies. This state of bliss may not last for too long. Considering the pace of price rise in crude oil, its impact is likely to be felt soon. Crude oil prices, which have already breached a level of $110 per barrel are up by nearly 10% since December end, compared to 15-25% fall in major stock indices during the period.

The rising oil prices are building up an underlying inflationary pressure. Though petroleum products’ prices are administered in India and there is an incomplete pass-through of the burden to the final consumers. Nearly a fifth of the incremental change in inflation was accounted for by fuel price index for the week ended March 3. The burden of in most visible in case of aviation turbine fuel (ATF), naptha and bitumen, which are traded at market-determined prices. There price are up by 27-39% year-on-year for the week-ended March 3. This will impact air travel, power and polymers (plastic products and synthetic material) directly. We need to prepare to pay more for most manufactured products in the future.

A strong demand growth and high profit margins have given India Inc the leeway to absorb a part of input cost hikes in the past. But, as corporate earnings have slowed and economic growth is likely to soften, companies are running out of headroom to absorb further increases in crude oil prices. Most manufacturers are expected to take a price hike and some have done so in last few month. More increases in crude prices or a hike in domestic fuel prices will build up more pressure.

Retail prices of petrol and diesel are unlikely to go up, considering the forthcoming general elections and higher food prices. The government may compensate oil-marketing companies by issuing more oil bonds and this will increase future subsidy burden. This will create more liabilities for the future government and raise fiscal deficit few years down the road. Oil bonds will only delay the pain and will come back to haunt tax-payers in future.

Another fallout of rising oil prices is the depreciation in rupee against dollar. A stronger rupee helps cool domestic inflation by lowering the price of imports, which include crude oil food and many industrial raw material. However, a weaker rupee adds fuel to the inflationary pressure in the domestic economy. Rupee has depreciated by 2.4% during the month ending March 18. The net import bill (underlying assumption is that domestic consumption will grow at a three-year CAGR of 3.75%) is likely to touch a level of Rs 2,47,580 crore by March 2009 (almost $62 billion at current exchange rate), recording a growth around 19%. Such heavy import bill will account almost 5.5% of GDP further weakening rupee.

In short, rising oil prices weigh heavily on Indian economy. The demand growth is showing signs of moderation especially in interest rate sensitive sectors such as construction, consumer durables and automobiles sector. In order to stimulate the growth, interest rate cut is expected. However, rising oil prices have put RBI in a dilemma. So far, RBI has fought inflation by cooling off investment lead economic growth and is likely to continue with this policy. But what if GDP growth slips below 7%. It will amount to a severe slowdown in economy coupled with oil induced inflation and may began to hurt all and sundry.

Time to be wary of this ‘elite’ PE100 club

TAKING cues from the unrest in the global financial markets, Indian stock markets have crashed substantially over last few days. The Sensex has come all the way down to 14,809 shedding 29% from 20,827.5 on January 11, 2008. In the same period the price to earnings mul tiple (P/E) of the Sensex has plunged from 28.4 to 19 — a level, which was last seen only in March 2007. The price-to-earnings multiple reflects the investors' confidence in the future earnings of the companies constituting the benchmark index.

With its daily dose of bad news the stock markets continue to plunder investors’ wealth every day. However, even in these despairing times a quite a number of companies continue to command three-digit P/Es. It must be accepted that the number of companies claiming such high P/Es have certainly come down during the market meltdown and even for others the P/Es have eroded. Nevertheless, a P/E above 100 is certainly an indication of strong investor confidence about a company's bright future. While such PE may be justified in case of few companies, the same can't be true for all the companies in our list.

The elite group of 100-plus PE companies includes the over 90 companies such as Reliance Natural Resources (RNRL), Educomp and Moser Baer among others. Here we are excluding the recently-listed companies, which are yet to publish their full year's financials. Although the real estate industry got a thorough beating in the recent meltdown the companies such as Bombay Dyeing, Phoenix Mills, Jaybharat Textiles, Godrej Industries continue to occupy place in this elite club thanks to their real estate ventures.

BF Utilities — the division of Kalyani Group of India, using windmills to power steel plants operated by the large manufacturing company — is also trading at PE above 100. Despite lack of any major exploration success the valuations of Hindustan Oil Exploration have stretched up based on its hydrocarbon reserves.

However, the investors need to be wary of the fancy valuations attracted by such companies, which can evaporate quickly into the thin air. For example, against 29% fall in the Sensex, companies such as Moser Baer, BF Utilities, RNRL, Jai Corp have already lost over 55% of their market capitalisation since first week of January 2008.

GAIL (INDIA): Time To Step On The Gas

Gail is likely to benefit from higher availability of natural gas in coming months. Its capex plans and growing businesses make it a good long-term investment

GAIL (INDIA) is the country's largest natural gas company with annual revenue of around Rs 17,000 crore and market capitalisation (m-cap) of around Rs 35,600 crore. The company owns and operates the largest natural gas pipeline network in India and handles over 75% of the total gas transported in the country. Gail is investing heavily to lay more pipelines to widen its reach, and will be a major beneficiary of the likely jump in domestic production of natural gas. Gas production in India is likely to double in the next couple of years, which may boost Gail’s gas transportation business. Investors can take exposure in Gail with a two-year horizon.

BUSINESS:
Currently, Gail operates in all segments of the natural gas value chain — from processing, transporting and marketing, to producing downstream petrochemicals using natural gas as feedstock. With a 6,800-km-long pipeline network, Gail continues to remain the largest natural gas transporter in India. In order to achieve backward integration, the company has invested in 29 exploration blocks and three coal bed methane (CBM) blocks. It recovers LPG from its seven natural gas treating plants and sells to oil marketing companies.

Gail has also invested in companies which cover other aspects of the natural gas business, such as liquefied natural gas (LNG), city gas distribution (CGD) and gas-based power projects. It has set up joint ventures in Russia, Egypt and China to market natural gas. The company has embarked on an ambitious expansion plan to invest nearly Rs 29,000 crore over the next five years to augment its gas pipeline network, exploration & production (E&P) activities, petrochemicals, city gas projects and LNG, among others. The completion of Gail’s capital expenditure (capex) programme, will help double its natural gas transmission capacity, extend retail gas sales to 200 cities, expand its LNG terminals and increase its petrochemicals capacity by 60%.

GROWTH DRIVERS:
The company's gains will accrue incrementally as the availability of natural gas improves in India. Within the next two years, the total domestic natural gas production is likely to double to 160 million cubic metres per day (mcmd) from the current 81 mcmd. The availability of natural gas is likely to further shoot up to 285 mcmd by ’12.

Currently, the central government plans to bring the gas produced by the Panna, Mukta and Tapti consortium to Gail for marketing from April ’08. This will boost the company’s revenues. Similarly, natural gas production from Reliance Industries’ Krishna Godavari (KG) basin oilfields is likely to start by mid-’08. Gail has already entered into a memorandum of understanding (MoU) with Reliance Industries (RIL) for transporting its gas. Moreover, Gail holds a stake in five E&P blocks, which have recently struck gas and are under development.

FINANCIALS:
Despite its robust performance, Gail’s growth has been stunted over the years due to the burden of sharing subsidy. During FY07, the discounts extended to oil marketing companies were equivalent to over 60% of Gail’s reported profit of Rs 2,386.7 crore. The company’s net profit has witnessed a compound annual growth rate (CAGR) of 14.4% over the past 10 years, while sales have posted a CAGR of 10.9%. Gail has consistently paid dividends, which have witnessed a CAGR of 21.4% during the same period. The company’s dividend yield currently works out to around 2.4%.

VALUATIONS:
Gail’s current market price of Rs 421.60 discounts its trailing 12 months earnings by 13.9 times, which appears fair, considering its current business profitability. However, the company is likely to post steady growth in the coming months, thanks to the increasing availability of natural gas and its capex plans.

With commissioning of new pipelines and improvement in gas availability, Gail is likely to earn additional revenues of Rs 1,250 crore annually by FY09 and another Rs 2,750 crore annually from FY11 onwards. This alone will translate into a CAGR of 16.7% in operating profit over the next four years.

Gail’s investments in petrochemicals, CGD and exploration business will add value to its business over the next 2-3 years. Long-term investors with a two-year horizon can accumulate the stock at its current price. Gail’s dividend yield is likely to rise to 4.5% by ’11 at historical cost, provided the company maintains its payout ratio. This is an added incentive for investors.

RISKS:
The company’s future profitability may suffer if its subsidy burden increases disproportionately.

With growth on its side, way ahead won’t be bad

The Current Sensex Level Justifies Itself Even At A Low P/E Of 15-16

THE current market meltdown has left the investors shocked and stunned. The only question in everyone’s mind today is does the market have further downside left or has it bottomed out? Practically, everyone is offering some or the other opinion on this question.

We believe that the one of the fundamental ways of reviewing the current market conditions is to look at valuations in the light
of their historical values. If, historically, a particular scrip was being valued at 10 times its annual earnings, then we can assume that it reflects its fair value. If the current valuations are substantially above these levels, it will mean that a further downside is to be expected.

The latest rally that the equity market witnessed throughout year 2007 peaking in the first week of 2008 stretched the valuations to historic highs. The bullish enthusiasm meant that the future growth potential of companies was discounted at higher rates than witnessed in the past. In terms of the market lingo, it meant that the price-toearnings multiples (P/Es) increased to very high level. At its peak in the first week of January 2008, the Sensex P/E had breached the 28 level and it matched the levels last seen during the height of the dotcom boom in 2000.

Reminding of the crash of 2000 could be painful for many investors. It was not only severe, but also long-lived and the bear grip on the markets remained tight for years. The BSE Sensex hit the bottom at 2,924 points in April 2003, when its P/E declined to 12.7. Only after this, the markets stabilised and then gained gradually. Since September 2007, in just three months, the Sensex gained around 33% — a gain that has been wiped out now. With the crash, the valuations too have moderated with the market capitalisation of Sensex at just 19.4 times its constituents’ trailing 12-month earnings. A study of the share price movement of the Sensex companies indicates that more than half of them are now trading below their 5-year average PE. Just 11 companies command a PE, which is higher compared with their average PE over past five years period.Does this mean that fundamentally speaking, the valuations have become reasonable and there is little, if any, downside left? It may not be so. A closer look reveals that the 11 scrips with higher PEs include RIL, ONGC, L&T, HDFC and ICICI. These companies together have 60% weightage in the Sensex, if their valuations were to come down to historical levels, the market will fall substantially.

Comparing the current crash with year 2000 puts forward a key question: will the aftereffects of the current crash continue over the next couple of years as witnessed in 2000? The answer would probably be ‘No’, as the situations differ considerably. India’s economy during the 2000-2003 period was passing through a lean phase and it was no wonder that it weighed down on the stock market. However, the economy is expected to post a growth of 8.7% in FY08 and the future growth, although slower, is expected to remain above 8%. Looking at the situation from a different angle, market experts are expecting earnings per share of Sensex companies to reach around Rs 950-1,000 levels in FY09. Thus, the current Sensex level justifies itself even at a low P/E of 15-16.

Rumours of bonus issue lift Gail

TALK of a bonus issue saw a brief euphoria grip the Gail counter on the bourses on Tuesday. News that its subsidiary Ratnagiri Gas and Power (RGPPL) will come out with an IPO to raise Rs 1,000 crore by end 2008, saw the scrip gain nearly 3% in ten minutes. The counter, however, lost steam thereafter. When contacted, the Gail management strongly denied any such move. The scrip that had closed at Rs 393 on Monday, gained almost 7% on Tuesday at Rs 420, before the news struck, only to end the day at similar levels after hitting an intra-day high of Rs 436. Gail ended FY-07 with accumulated reserves worth 12.5 times its paid-up equity, which makes it susceptible to bonus rumours from time to time.

SHIV-VANI Oil & Gas Exploration Services: Join The Treasure Hunt

Shiv-Vani will generate healthy returns over the next 18-24 months, given its bulging order book and favourable outlook for the E&P sector

SHIV-VANI Oil & Gas Exploration Services is one of India’s leading companies providing integrated support services to onshore petroleum exploration companies. It clocked a turnover of Rs 400 crore during the year ended December ’07. It is the only player in the country to provide integrated services for developing coal bed methane (CBM) projects. Considering its bulging order book position and favourable outlook for the exploration and production (E&P) industry in India, the company will generate healthy returns over the next 18-24 months.

BUSINESS:
Shiv-Vani offers integrated service solutions for exploration of oil and natural gas till their exploitation. Its involvement in an E&P block starts with seismic surveys and continues till drilling, apart from repair and maintenance of oil wells. Shiv-Vani owns 25 onshore rigs, with seven more set to join the fleet by June ’08. It has tied up with Express Drilling of the US to emerge as the only integrated CBM services provider in India. It mainly works for PSUs like ONGC and Oil India. It operates from three bases and owns 600 transport vehicles, which makes it easy to move equipment to remote locations. It is executing a few contracts in Oman and the US; these accounted for a quarter of its revenues last year.

GROWTH DRIVERS:
India’s exploration industry has received a boost due to the government’s New Exploration Licensing Policy (NELP). Considering high crude oil prices and commitments of E&P companies under earlier NELP rounds,the boom in the domestic E&P sector may continue. This will drive demand for services provided by Shiv-Vani. Its unexecuted order book stands at over Rs 3,500 crore, of which, 70% will be executed in the next 24-30 months. Its first CBM contract, worth Rs 650 crore, with ONGC started in December ’07. This will boost its revenues and profits from March ’08 quarter onwards.

FINANCIALS:
Shiv-Vani has registered a cumulative annual growth rate of 78.7% in net profit over the past four years, while sales grew 42.8%. During the 12-month period ended December ’07, its net profit more than doubled to Rs 76 crore, while net sales surged 44% to Rs 395 crore. The company plans to close this accounting year for the 15-month period in March ’08 .

VALUATIONS:
Shiv-Vani is trading at 28.1 times its trailing 12-month EPS. In comparison, at CMP, its forward P/E works out to 13, based on FY09 estimated earnings. We estimate Shiv-Vani to close FY09 with topline of Rs 1,000 crore and net profit of Rs 200 crore. This provides upside potential for long-term investors. The estimate accounts for 25% equity dilution over the next 18 months on conversion of outstanding convertible bonds and warrants.

No tax sop for new refinery projects

BUDGET MEMORANDUM HAS INTRODUCED SUNSET CLAUSE FOR 100% TAX EXEMPTION FOR MINERAL OIL REFINING, POST ’09

INVESTMENTS by oil refiners in new refinery projects could be in jeopardy after the latest Union Budget, which has a provision that strips new refinery projects of income tax benefits. As things stand, a petroleum refinery is eligible for 100% income tax exemption for the first seven years of its operation. The Budget memorandum has now introduced a Sunset clause for 100% tax exemption for refining of mineral oil, if the project starts after April 2009.

This means the new refineries will no longer enjoy the I-T benefits, under Section 80-IB of the Income-Tax Act that other projects have had. If implemented, the provision could grossly reduce the return on capital and increase the payback period for new refinery projects. SV Narasimhan, finance director of India’s largest petroleum refining company Indian Oil, expressed concern over the development. “The removal of tax benefits is a big concern for the industry. Considering the huge investment needed in setting up a re finery, these incentives were essential for their economics to work out well We plan to take up this issue with the government at the earliest to restore these benefits,” he said. Industry sources said the move could impact new investments in the business.

Among those facing the heat imme diately will be Bharat Petroleum’s Bina refinery and the Hindustan Petroleum Mittal joint venture refinery at Bhatin da. The Rs 10,500-crore Bina refinery is expected to be completed by December 2009, while the Bhatinda refinery is scheduled to commence operations only by end of 2010. Both will not be el igible to claim tax benefits. However Reliance Petroleum’s 27-million-tonne new refinery at Jamnagar is luckier, as it is on schedule to commission opera tions by December 2008.

Tax consultants Ernst & Young ac knowledged the problem in their re port on the Union Budget 2008. The report said, “The removal of tax holi day on refining will adversely impact new refinery projects.” Tax holiday claims for production of natural gas could also be questioned in the future the report said.

The Budget has actually proposed a new provision in sub-section (9) of Sec tion 80-IB, to provide that no deduc tion will be allowed to a mineral oil re finer if they begin operations after April 2009. However, confusion exists with the same Budget memorandum re defining the words ‘mineral oil’. Ac cording to the memorandum, “For the purpose of this section, the term ‘min eral oil’ does not include petroleum and natural gas, unlike in other sections of the Act.” In the absence of any clear un derstanding as to what ‘mineral oil would mean if not petroleum crude most of the refiners are convinced that their new projects will get hit. Howev er, one public sector refiner said the de velopment does not apply to the petro leum refining sector.

OIL’S NOT WELL
Currently, a petroleum refinery is eligible for 100% I-T exemption for the first 7 years of operation
This means the new refineries will no longer enjoy the I-T benefits, under Section 80-IB of the Income-Tax Act
Among those facing the heat immediately will be Bharat Petroleum’s Bina refinery and the Hindustan Petroleum-Mittal joint venture refinery at Bhatinda
However, Reliance
Petroleum’s 27-million-tonne new refinery at Jamnagar is luckier, as it is expected to be commissioned by Dec ’08

TROUBLE AT HOME

EXCISE PAIN FOR PETCHEM PLAYERS

BUDGET 2008 HAS MADE IT MORE DIFFICULT for export-oriented units (EOUs) to sell in the domestic market. EOUs, generally eligible to sell up to 50% of their annual sales domestically, will now have to pay customs duty at 50% of applicable rates for such sales, compared to 25% till now. India’s largest petrochemicals company, Reliance Industries (RIL), whose Jamnagar refinery enjoys EOU status, is likely to be affected by the change. Others like South Asian Petrochemicals and IG Petrochemicals, which enjoy EOU status, will also witness an erosion in their competitive advantage when selling in India.

Also, costs are likely to go up for polymer manufacturers as the finance minister has reimposed 5% import duty on naphtha, from nil last year. “Thanks to a complex regime of export benefits and duty exemptions, naphtha is exported from refineries and is imported by manufacturers of polymers, leading to price distortions and revenue losses,” he said.

This will adversely impact companies like RIL and Haldia Petrochemicals, which use naphtha for polymer production. Till now, RIL used to export naphtha from its refinery availing of the benefits of being an EOU, while its erstwhile subsidiary IPCL used to import it duty-free.

Petrochemicals manufacturers are not happy with the development. “We are disappointed by the re-imposition of 5% import duty on naphtha used in production of polymers. This is not in line with the basic rule that customs duty on raw materials should be less than that on the finished product,” said Chemicals and Petrochemicals Manufacturers Association of India president KG Ramanathan.

The general reduction in excise rates from 16% to 14% and the cut in central sales tax to 2% will help the petrochemicals industry. “The waiver of loans and interests to farmers will help increase plastic consumption in the agriculture sector,” said Supreme Industries MD MP Taparia.

The fertiliser industry will benefit from the reduction in duty on sulphur, which has been cut from 5% to 2%.